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Journal of Law, Economics, and Organization Advance Access published online on December 9, 2008
Journal of Law, Economics, and Organization, doi:10.1093/jleo/ewn024
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© The Author 2008. Published by Oxford University Press on behalf of Yale University. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org

Double-Sided Moral Hazard, Efficiency Wages, and Litigation

Oliver Gürtler*

University of Bonn

Matthias Kräkel**

University of Bonn

* Department of Economics, University of Bonn. Email: oliver.guertler{at}uni-bonn.de

** Department of Economics, University of Bonn. Email: m.kraekel{at}uni-bonn.de.

We consider a moral-hazard problem in a principal-agent relationship. Each party can renege on the signed contract since verification of effort is costly and subject to uncertainty. It is shown that ex-post litigation can restore incentives of the agent. Moreover, when the litigation can be settled by the parties, the pure threat of using the legal system may suffice to implement the first-best solution. This finding is quite robust. In particular, it holds for situations where the agent is protected by limited liability, where the parties have different technologies in the litigation contest, or where the agent is risk averse. (JEL D86, J33, K41)


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