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Optimal cash-in-advance contracts under weak third-party enforcement

Philippine Review of Economics

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Title Optimal cash-in-advance contracts under weak third-party enforcement
 
Creator Fabella, Raul V.; University of the Philippines School of Economics
 
Subject Cash-in-advance contracts; agent opportunism; weak TPE; flight to spot contracts
 
Description We explore the implications of North’s weak third-party enforcement (TPE) on the structure of the ex ante incentives-compatible contracts that require an advance payment by the principal to the agent. This generates appropriable quasi-rent, which the agent can appropriate. To deal with this, we introduce a stronger constraint, the augmented participation constraint, reflecting the quality of tpe that prompts a distinction between insider reservation and outsider reservation utility. We show that a falling TPE raises the agent’s insider reservation utility, reducing the principal’s profit and his willingness to contract. When the cash-in-advance commitment is endogenous, its optimal level falls as TPE falls. tpe erosion thus leads to either the nonexistence of or the flight from more productive contracts and exchange, leading to North’s observation of poorer economic performance. JEL classification: O22, O26, 611
 
Publisher Philippine Review of Economics
 
Contributor —
 
Date 2010-09-30
 
Type info:eu-repo/semantics/article
info:eu-repo/semantics/publishedVersion
Peer-reviewed Article
 
Format application/pdf
 
Identifier http://www.econ.upd.edu.ph/pre/index.php/pre/article/view/194
 
Source Philippine Review of Economics; Vol 46, No 1 (2009)
1655-1516
 
Language eng
 
Relation http://www.econ.upd.edu.ph/pre/index.php/pre/article/view/194/678
 
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