Moral Hazard and Renegotiation of Multi-Signal Contracts

Abstract

We study the costs and benefits of additional information in agency contracts, when there is the possibility of renegotiation. The literature to date assumes that contractual simplicity, i.e. the omission of informative contractual contingencies, can only arise in multi-period environments, and only in a specific manner in which it is interim information that is excluded. In contrast, we show that in certain circumstances, it is also efficient to restrict the set of contingencies in a standard one period contract, where all information arrives at once. Although increasing the number of contingencies will always decrease the agency cost, it can have the adverse effect of weakening the principal's commitment not to renegotiate, thus undermining ex ante incentives to exert effort. Applications to several real world phenomena are briefly explored.

Keywords: Moral Hazard, Renegotiation, Commitment, Multiple Signals, Contractual Simplicity

JEL Classification: D86