Moral Hazard and the Property Rights Approach to the Theory of the Firm

11 Pages Posted: 17 Jan 2020

See all articles by Patrick W. Schmitz

Patrick W. Schmitz

University of Cologne; Centre for Economic Policy Research (CEPR)

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Date Written: January 1, 2020


In the Grossman-Hart-Moore property rights theory, there are no frictions ex post (i.e., after non-contractible investments have been sunk). In contrast, in transaction cost economics ex-post frictions play a central role. In this note, we bring the property rights theory closer to transaction cost economics by allowing for ex-post moral hazard. As a consequence, central conclusions of the Grossman-Hart-Moore theory may be overturned. In particular, even though only party A has to make an investment decision, B-ownership can yield higher investment incentives. Moreover, ownership matters even when investments are fully relationship-specific (i.e., when they have no impact on the parties' disagreement payoffs).

Keywords: incomplete contracts, ownership rights, investment incentives, relationship specificity, moral hazard

JEL Classification: D23, D86, G34, L23, L24

Suggested Citation

Schmitz, Patrick W., Moral Hazard and the Property Rights Approach to the Theory of the Firm (January 1, 2020). Economics Letters, Vol. 186, No. 108514, 2020, Available at SSRN:

Patrick W. Schmitz (Contact Author)

University of Cologne ( email )

Cologne, 50923


Centre for Economic Policy Research (CEPR)

United Kingdom

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