Self-evident events and the value of linking

Abstract

We study a T-period contracting game between a group of players without access to external financing. We show that the long-term efficiency loss is bounded from below by the need to vary incentives across self-evident events. When T is large, the efficiency bound can be approached by a contract that involves side payments between players. Our results apply to all monitoring structures and strategy profiles. They encompass the inefficiency result in Abreu et al. (1991), as well as the approximate-efficiency results in Compte (1998), Obara (2009), and Chan and Zhang (2016).