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The Threat of Exclusion and Implicit Contracting

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  • Martin Brown
  • Marta Serra-Garcia
Abstract
Implicit contracts can mitigate moral hazard in labor, credit and product markets. The enforcement mechanism underlying an implicit contract is the threat of exclusion: the agent fears that he will lose future income if the principal breaks off the relationship. This threat may be very weak in environments where an agent can appropriate income-generating resources provided by the principal. For example, in credit markets with weak creditor protection borrowers may be able to appropriate borrowed funds and generate investment income without requiring further loans. We examine implicit contracting in a lending experiment where the threat of exclusion is exogenously varied. We find that weak exclusion undermines implicit contracting: it leads to a more frequent breakdown of credit relationships as well as to smaller loans.

Suggested Citation

  • Martin Brown & Marta Serra-Garcia, 2016. "The Threat of Exclusion and Implicit Contracting," CESifo Working Paper Series 6092, CESifo.
    • Handle: RePEc:ces:ceswps:_6092
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    Cited by:

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    More about this item

    Keywords

    Economics: microeconomic behavior; behavior and behavioral decision making; Finance: corporate finance; implicit contracting;
    All these keywords.

    JEL classification:

    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance
    • F21 - International Economics - - International Factor Movements and International Business - - - International Investment; Long-Term Capital Movements
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems

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