Moral hazard and the property rights approach to the theory of the firm

Abstract

In the Grossman–Hart–Moore property rights theory, there are no frictions ex post (i.e., after non-contractible investments have been sunk). In contrast, in transaction cost economics ex-post frictions play a central role. We bring the property rights theory closer to transaction cost economics by allowing for ex-post moral hazard. As a consequence, central conclusions of the Grossman–Hart–Moore theory may be overturned. In particular, even though only party A has to make an investment decision, B-ownership can yield higher investment incentives. Moreover, ownership matters even when investments are fully relationship-specific (i.e., when they have no impact on the parties’ disagreement payoffs).