Working Paper: CEPR ID: DP6725
Authors: Susanne Ohlendorf; Patrick W. Schmitz
Abstract: We consider a repeated moral hazard problem, where both the principal and the wealth-constrained agent are risk-neutral. In each of two periods, the principal can make an investment and the agent can exert unobservable effort, leading to success or failure. Incentives in the second period act as carrot and stick for the first period, so that effort is higher after a success than after a failure. If renegotiation cannot be prevented, the principal may prefer a project with lower returns; i.e., a project may be "too good" to be financed or, similarly, an agent can be "overqualified."
Keywords: Dynamic Moral Hazard; Hidden Actions; Limited Liability
JEL Codes: C73; D86
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Principal's commitment not to renegotiate (D86) | Agent's effort level in second period (Z22) |
| Successful first-period outcome (P17) | Agent's effort level in second period (Z22) |
| Inability to commit (D91) | Principal prefers projects with lower returns (G11) |
| Inability to commit (D91) | Inefficiencies in project selection (H43) |