Long-Term Contracting with Time-Inconsistent Agents
68 Pages Posted: 25 May 2018 Last revised: 7 Mar 2019
Date Written: March 6, 2019
We study contracts between partially naive present-biased consumers and risk neutral firms in settings with one- and two-sided commitment. Our main result is that as the number of periods grows, the welfare loss from present bias vanishes. We use the model to study two common regulatory interventions: removing commitment power from consumers and imposing limits on the fees that firms can charge. For each fixed contracting horizon, removing commitment power increases welfare when consumers are sufficiently present-biased. However, removing commitment power cannot help if the contracting horizon is long. With one-sided commitment, setting a maximum fee never benefits consumers. Overall, there are two possible interpretations of our main finding: either there is no role for regulation to correct for present bias when contractual relationships are long enough, or something must be missing from how these markets are typically modeled.
JEL Classification: D81, D86, D91, I18
Suggested Citation: Suggested Citation