Wait-and-See or Step in? Dynamics of Interventions

59 Pages Posted: 12 Sep 2018 Last revised: 16 Oct 2018

See all articles by Dana Foarta

Dana Foarta

Stanford Graduate School of Business

Takuo Sugaya

Stanford Graduate School of Business

Date Written: September 24, 2018

Abstract

We study when and how intervention to stop a project is optimally used in a repeated relationship between a principal and a policymaker. The policymaker is privately informed about his ability, where a higher ability policymaker has a lower cost of producing a good project. He also privately chooses how much effort to supply on the project. Before the project is completed, the principal receives a signal about its outcome and can intervene to stop it from taking effect. Intervention may prevent a bad outcome, but no intervention leads to better learning about the policymaker's ability. In the benchmark with observable effort, it is optimal to intervene only when the policymaker's reputation is sufficiently low. If effort is not observable, the optimal response features switching between intervention and no intervention on the equilibrium path. The model rationalizes intervention technologies implemented in practice by supranational agreements and governing coalitions.

Keywords: Interventions, Early Warnings, Institutional Structure, Adverse Selection, Moral Hazard

JEL Classification: D78, D82, H77

Suggested Citation

Foarta, Dana and Sugaya, Takuo, Wait-and-See or Step in? Dynamics of Interventions (September 24, 2018). Stanford University Graduate School of Business Research Paper No. 18-41. Available at SSRN: https://ssrn.com/abstract=3243123 or http://dx.doi.org/10.2139/ssrn.3243123

Dana Foarta (Contact Author)

Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

Takuo Sugaya

Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States

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