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Observable Contracts as Commitments: Interdependent Contracts and Moral Hazard
Author(s) -
Katz Michael L.
Publication year - 2006
Publication title -
journal of economics and management strategy
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.672
H-Index - 68
eISSN - 1530-9134
pISSN - 1058-6407
DOI - 10.1111/j.1530-9134.2006.00114.x
Subject(s) - moral hazard , interdependence , agency (philosophy) , set (abstract data type) , action (physics) , folk theorem , observable , microeconomics , economics , business , law and economics , mathematical economics , actuarial science , computer science , game theory , repeated game , incentive , political science , epistemology , law , equilibrium selection , philosophy , programming language , physics , quantum mechanics
A large literature examines the use of observable and unrenegotiable agency contracts as commitments. These analyses generally impose an ad hoc restriction that contracts cannot be contingent on one another. I relax this restriction and obtain a folk theorem. Unlike earlier folk theorems in this area, the present result applies to agency relationships that have hidden‐action problems. Using an example, I also demonstrate that there are settings in which interdependent contracts support a strictly larger set of equilibrium outcomes than do independent contracts. The result highlights the critical need for careful thought about restrictions placed on the set of feasible contracts.