Publicity

We analyze the effects of publicity and mass media on the contract terms and outcomes in a simple model. Mass media affects contract outcomes because it affects public sentiment regarding the contract, which, in turn, may also affect reputation costs. This interaction of the public with the parties involved in a private contract has been virtually ignored in standard economic theories, simply because the public are outsiders to a private contract. In reality, however, mass media interacts with private contracting in the name of justice, fairness, and sympathy among others. This study incorporates such an interaction into a simple model of moral hazard. In our model, the interaction is reflected in the form of a minimum payment perceived by the public. We find that public sentiment may improve efficiency by utilizing observable but not contractible information. Furthermore, the first-best outcomes are obtainable. While a high minimum payment may achieve a first-best outcome, it may also cause a conflict between the contract parties because the benefit to one party can be a cost to the other party. If the minimum payment is too high, then social welfare may become low, because the principal avoids contracting. Another interesting finding is that contract does not have to be fully implemented. Specifically, the payment under a bad outcome is optimally set below the minimum payment, which means the payment will never be implemented. While not implementable, it still has an incentive effect on the agent. This result shows an interesting twist of the standard economic analysis. Our model provides insight regarding the ex-post conflicts between contract parties that can never be observed if the contract is fully implementable.