Self-enforcing contracts with persistence

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.

dynamic moral hazard; limited commitment; persistence; productivity; relational contracts

Self-enforcing contracts with persistence Articles