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On the Value of Commitment with Asymmetric Information

Patrick Rey
Bernard Salanie

Abstract

Several recent papers have emphasized that long-term relationships can be efficiently governed by short-term contracts, provided that there is no asymmetric information at the contracting dates. This excludes not only adverse selection problems, but also moral hazards problems in which hidden actions generate private information over the future. In this paper we show, in the context of a multiperiod principal-agent relationship with adverse selection, that renegotiable short-term contracts can be as efficient as long-term renegotiation-proof contracts. On the other hand, spot contracting may fail to achieve long-run efficiency not only because of intertemporal smoothing, as with symmetric information, but also because of ratchet effects and time inconsistency in the optimal structure of informational rents. Thus some limited commitment seems to be a necessary and sufficient condition to achieve long-run efficiency.