Contracts and Induced Institutional Change

While traditional contract theory takes the institutional environment as exogenously given, this paper analyzes how the agents' incentives to (de)centralize authority change when contracts are anticipated. In our model, induced institutional change will always harm the principal, and, under specified conditions, the outcome can be the reverse of what the principal seeks. The theory's applications span from industrial organization, when collusion influences mergers, to environmental conservation agreements, when tropical countries strategically decide on whether to (de)centralize forest management. These decisions may change when conservation agreements are anticipated; the consequence can be increased deforestation overall, despite the principal's payments for conservation.