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American Economic Review: Vol. 101 No. 7 (December 2011)

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Relational Contracts and the Value of Loyalty

Article Citation

Board, Simon. 2011. "Relational Contracts and the Value of Loyalty." American Economic Review, 101(7): 3349-67.

DOI: 10.1257/aer.101.7.3349

Abstract

This paper characterizes the optimal contract for a principal who repeatedly chooses among N potential agents under the threat of holdup. Over time, the principal would like to trade with different agents; however, the possibility of ex-post opportunism allows agents to collect rents and creates a fixed cost of initiating new relationships. In the optimal contract, the principal divides agents into "insiders" with whom she trades efficiently, and "outsiders" whom she is biased against. The optimal contract is self-enforcing if the principal is sufficiently patient and can be implemented by an "employment contract" that is robust to asymmetric information. (JEL: C73, D82, D83, D86)

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Authors

Board, Simon (UCLA)

JEL Classifications

C73: Stochastic and Dynamic Games; Evolutionary Games; Repeated Games
D82: Asymmetric and Private Information
D83: Search; Learning; Information and Knowledge; Communication; Belief
D86: Economics of Contract: Theory


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