An Aggregate Model of Firm Specific Capital with and without Commitment

Abstract

This paper studies the implications of an agency problem on the equilibrium outcome of an intertemporal model. The model considered is a two-period lived overlapping generations model with an aggregate productivity shock. In each generation, a subset of the agents, the entrepreneurs, choose the asset specificity of their projects. An agency problem exists because the entrepreneurs cannot commit to supplying their human capital which is essential to the project. I compare equilibria with and without commitment. The main result is that in the long run, the equilibrium without commitment has lower asset specificity and per capita output, and the productivity shocks have more lasting effects. However, it need not have larger aggregate fluctuations.