Time-Inconsistency, Renegotiation, and Firm Ownership

Research Seminars
Academic Areas Economics and Public Policy
Karna Basu, Assistant Professor, Department of Economics Hunter College, City, University of New York
July 12, 2013 | 3:00 PM - 4:00 PM | Friday
AC 2 Mini Lecture Theatre (MLT), hyderabad, Hyderabad, India
For ISB Community
Abstract: In this paper, we study optimal firm ownership form by lenders in markets where consumers may be time-inconsistent. Starting with Hansmann (1980), a number of papers have provided explanations for the existence of commercial nonprofit firms. Glaeser and Shleifer (2000) build a model in an incomplete contracts framework where a firm might optimally choose to operate as a non-profit rather than as a for-profit firm to credibly signal it has weaker incentives to take advantage of customers in the provision of goods or services where some dimension of quality may be ex-ante difficult to contract upon. In Bubb and Kaufman (2011), the non-contractibility is on hidden borrower penalties, which are incurred with certainty by some consumers, rather than quality. In this paper, we extend and modify Hansmann’'s insight to account for time-inconsistent borrowers. We show how, when there are strategically behaving time-inconsistent agents and profit-minded lenders, lenders might choose non-profit status even if there is no incomplete contracts problem. Here, there is a renegotiation problem instead, and firms choose nonprofit status to credibly signal that they will not renegotiate the terms of loan contracts (even if at that later date both the borrower and lender would like to). We build a framework to examine equilibrium contracts and firm ownership forms that is useful for explaining why some lenders (like credit card companies) offer consumers opportunities to renegotiate repayment terms while others (like microfinance institutions) offer much less flexibility.