Dynamic Relational Contracts with Credit Constraints

This paper considers a long-term relationship between two agents whoundertake costly actions or investments which produce a joint benefit. Agentshave an opportunity to expropriate some of the joint benefit for their ownuse. The question asked is how to structure the investments and division ofthe surplus over time so as to avoid expropriation. It is shown thatinvestments may be either above or below the efficient level and that actionsand the division of the surplus converges to a stationary solution at whicheither both investment levels are efficient or both are below the efficient level.