Many separable dynamic incentive problems have primal recursive formulations in which utility promises serve as state variables. We associate families of dual recursive problems with these by selectively dualizing constraints. We make transparent the connections between recursive primal and dual approaches, relate value iteration under each and give conditions for such value iteration to be con...

Thinking about contingencies, designing covenants and seeing through their implications is costly. Parties to a contract accordingly use heuristics and leave it incomplete. The paper develops a model of bounded rationality and examines its consequences for contractual design. It is argued that cognition is a natural source of adverse selection in contractual relationships, that contracts may be...

Credit default swaps (CDSs) are thought to ease borrowing by protecting lenders against default. This paper develops a model of the demand for CDS when borrowers choose the riskiness of investment and verification is imperfect. The model shows that CDSs may lead to risk-shifting, increasing the probability of default. Our model provides new insights on the role of CDS during the recent financia...

When real estate agent effort is unobservable, home sellers do not prefer the lowest possible commission rate because such a rate does not induce sufficient effort from agents. As a result, the optimal commission from the seller’s perspective exhibits downward rigidity, even if there is free entry. The analysis shows that downward rigidity will occur if and only if the quasi-fixed costs of sell...

In liability lawsuits (e.g., patent infringement), a plaintiff demands compensation from defendant, and the parties often negotiate settlement to avoid costly trial. Liability insurance creates bargaining leverage for defendant in this negotiation. We study characteristics of monopoly equilibrium contracts settings where effect is substantial source value insurance. Our results show that under ...

It is well-known that in two-sided matching markets (with contracts) that the existence of a stable outcome can be guaranteed if and only if agents’ preferences are substitutable and contracts are bilateral. We show that, in markets with a continuum of each type of agent, it is only necessary that agents on one side of the market have substitutable preferences in order to guarantee the existenc...

We study how to design an optimal government loan program for risky R&D projects with positive externalities. With adverse selection, the contract involves a high interest rate but nearly zero cofinancing by entrepreneur. This contrasts sharply observed schemes. selection and moral hazard, allowing two levels of effort entrepreneur, policy consists menu at most contracts, one self-financing...

We study bargaining over contingent contracts in problems where private information becomes public or verifiable when the time comes to implement agreement. suggest a simple, two-stage game that incorporates important aspects of bargaining. characterize equilibria which parties always reach agreement, and their limits as frictions vanish. Under mild regularity conditions, we show all interim-ef...

We study subgame-perfect implementation (SPI) mechanisms that have been proposed as a solution to incomplete contracting problems. show these mechanisms, which are based on off-equilibrium arbitration clauses impose large fines for lying and the inappropriate use of arbitration, severe behavioral constraints because induce retaliation against legitimate uses arbitration. Incorporating reciproci...