Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/189330 
Year of Publication: 
2005
Series/Report no.: 
Queen's Economics Department Working Paper No. 1050
Publisher: 
Queen's University, Department of Economics, Kingston (Ontario)
Abstract: 
Societies provide institutions that are costly to set up, but able to enforce long-run relationships. We study the optimal decision problem of using self-governance for risk sharing or governance through enforcement provided by these institutions. Third-party enforcement is modelled as a costly technology that consumes resources, but permits the punishment of agents who deviate from ex-ante specified allocations. We show that it is optimal to employ the technology whenever commitment problems prevent first-best risk sharing, but never optimal to provide incentives exclusively via this technology. Commitment problems then persist and the optimal incentive structure changes dynamically over time with third-party enforcement monotonically increasing in the relative inequality between agents.
Subjects: 
Limited Commitment
Risk Sharing
Third-party Enforcement
JEL: 
C73
D60
D91
K49
Document Type: 
Working Paper

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