Observable Contracts as Commitments: Interdependent Contracts and Moral Hazard

Abstract

A large literature examines the use of observable and unrenegotiable agency contracts as commitments. These analyses generally impose an ad hoc restriction that contracts cannot be contingent on one another. I relax this restriction and obtain a folk theorem. Unlike earlier folk theorems in this area, the present result applies to agency relationships that have hidden-action problems. Using an example, I also demonstrate that there are settings in which interdependent contracts support a strictly larger set of equilibrium outcomes than do independent contracts. The result highlights the critical need for careful thought about restrictions placed on the set of feasible contracts.