Contractual interest
Exercise
How would a decrease in the interest rate affect: (a) contractual performance in the case of existing obligations and (b) contractual safeguards (i.e., the use of different safeguarding technologies)? (You must answer the two questions separately).
Analysis
a) Performance in extant contracts will be enhanced in the short term, because the present value of safeguarding quasi-rents increases.
b) A lower stream of quasi-rents is needed to motivate the same level of performance. As a consequence, there will probably be a tendency to use more safeguarding mechanisms that take the form of deferred compensation (quasi-rents) as opposed to, e.g., direct monitoring, because lower investments are needed to achieve a certain level of quasi-rents.
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