How to Commit (If You Must): Commitment Contracts and the Dual-Self Model

Abstract

This paper studies how dual-self (Fudenberg and Levine (2006)) decision-makers can use commitment technologies to combat temptation and implement long-run optimal actions. I consider three types of commitment technologies: carrot contracts (rewards for 'good' behavior financed by borrowing from future consumption), stick contracts (self imposed fines for 'bad' behavior) and binding commitment. I compare the welfare implications of these contracts and show that dual-self decision-makers strictly prefer to use carrots instead of either sticks or binding commitments. This is for several reasons: sticks are highly vulnerable to trembles (while carrots are not), sticks and bind- ing commitments create a temptation to cancel them (while carrots do not), and finally carrots allow easy tradeoffs between commitment and flexibility (while sticks and binding commitments do not).

Keywords: behavioral economics, dual self model, commitment contracts, self control