Working Paper: CEPR ID: DP2680
Authors: Juan D. Carrillo; Mathias Dewatripont
Abstract: This Paper considers a time-inconsistent individual who has the ability to make promises that lead to a financial or reputation loss if broken. We first identify conditions under which promises made are kept, and conditions under which they are (partially) broken. Second, we endogenize the financial loss from breaking promises by considering interpersonal monitoring and explicit contracting. We describe optimal contracting under the assumptions that monitoring requires meeting and that meeting also opens the door to renegotiation of earlier promises. Third, we show how the loss from breaking promises can be reinterpreted in terms of reputation loss in the presence of incomplete information. Finally, we argue that the above results remain valid when we replace time-inconsistent preferences with limits to contracting as the source of the commitment problem of the individual. This significantlyenhances the generality of these results.
Keywords: hyperbolic discounting; limits to contracts; promises; time inconsistency
JEL Codes: A12; D84
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| marginal cost of breaking promises increases (D86) | promises will be kept (F53) |
| interpersonal monitoring enhances credibility of promises (Z13) | promises are more likely to be kept (D14) |
| incomplete information about effort costs (D89) | promises can still serve as commitment devices (D86) |
| promises induce buyers to choose more ambitious technologies (O33) | higher-cost sellers benefit (D40) |
| limits to contracting (K12) | effectiveness of promises remains valid (D86) |