Self-enforcing contracts with persistence.

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Date: May 2022
Publisher: Elsevier B.V.
Document Type: Report
Length: 425 words

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Abstract :

Keywords Dynamic moral hazard; Productivity; Relational contracts; Persistence; Limited commitment Highlights * The paper presents a model combining two premises: (i) the reliance on self-enforcing contracts due to limited legal enforcement and (ii) persistent productivity. * The model may provide a possible rationale why countries with the worse rule of law might exhibit: (i) higher aggregate TFP volatilities, (ii) larger dispersion of firm-level productivity, and (iii) greater wage inequality. * We provide suggestive empirical evidence consistent with the model's aggregate implications. * We relate the model's firm-level implications to existing empirical findings. * Our model provides a unified framework to understand various phenomena at both micro and macro levels. Abstract We show theoretically that, in the presence of persistent productivity shocks, the reliance on self-enforcing contracts due to limited legal enforcement may provide a possible rationale why countries with the worse rule of law might exhibit: (i) higher aggregate TFP volatilities, (ii) larger dispersion of firm-level productivity, and (iii) greater wage inequality. We also provide suggestive empirical evidence consistent with the model's aggregate implications. Finally, we relate the model's firm-level implications to existing empirical findings. Author Affiliation: (a) Universidad Carlos III de Madrid, Spain (b) Universidad Carlos III de Madrid and University of Texas at Austin 2110 Speedway CBA 6.276, Austin, TX, USA (c) Chinese University of Hong Kong, Hong Kong * Corresponding author. Article History: Received 15 June 2021; Revised 23 March 2022; Accepted 28 March 2022 (footnote)[white star] Many thanks to the editor and the anonymous referee for providing many constructive suggestions. We are also grateful to Nicolas Aragon, Sudipto Dasgupta, Joonkyo Hong, Christian Laux, Qing Liu, Gregor Matvos, Jacopo Ponticelli, Andy Skrzypacz, Chad Syverson, Sheridan Titman, Giorgio Zanarone, seminar participants at Korea University, Universidad Carlos III de Madrid, University of Minnesota, UT Austin, Vienna Graduate School of Finance, 2021 Greater Bay Area Finance Conference, Utah Winter Business Economics Conference, the 4th Relational Contracts Workshop at University of Chicago, the Society for the Advancement of Economic Theory Conference 2019 at Ischia, the 4th FTG European Summer Meeting at Madrid, and Virtual Finance Theory Seminar for helpful comments. Dumav gratefully acknowledges support from from the European Union's Horizon 2020 research and innovation programme under the Marie Sklodowska-Curie grant # 896463, and the Ministerio Economia y Competitividad (Spain) through grants ECO2017-86261-P and MDM 2014-0431. Fuchs gratefully acknowledges support from the ERC Grant # 681575, Ministerio Ciencia Innovacion y Universidades (Spain), Grants PGC2018-09615 and MDM2014-0431, and from the Comunidad de Madrid, Grant H2019/HUM-5891. Byline: Martin Dumav [mdumav@eco.uc3m.es] (a), William Fuchs [william.fuchs@mccombs.utexas.edu] (b), Jangwoo Lee [jangwoolee@cuhk.edu.hk] (*,c)

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Gale Document Number: GALE|A703193416