The role of installment payments in contracts for services

This article studies the role of installment payments in relationships characterized by moral hazard and sunk costs. We rule out vertical integration and payments contingent on the product of the contractor. Instead, each payment is negotiated as and when made. In such circumstances, an initial (down)payment serves to redress the weakness of the contractor in ex post renegotiations. Ifhigher effort by the contractor in thefirst stage increases the marginal product of effort in the second stage, a second installment payment induces the contractor to invest greater effort initially.