How to Commit (If You Must): Commitment Contracts and the Dual-Self Model

This paper studies how dual-self (Fudenberg and Levine (2006)) decision-makers can use commitment technologies to combat temptation and implement long-run optimal actions. I consider two types of such technologies: carrot contracts (rewards for ‘good’ behavior financed by borrowing from future consumption) and stick contracts (self imposed fines for ‘bad’ behavior). Both types of contracts can simulate binding commitment when it is not available and thus offers of such contracts make DMs better off. I show that the exact properties of optimal carrots and sticks depend crucially on the short-run discount rate and the time it takes for the contract to ‘kick in.’ Finally, I compare the welfare implications of these contracts and show that dual-self decision-makers strictly prefer to use carrots instead of either sticks or binding commitments. This is for several reasons: sticks are highly vulnerable to trembles (while carrots are not), sticks and binding commitments create a temptation to cancel them (while carrots do not), and finally carrots allow easy tradeoffs between commitment and flexibility (while sticks and binding commitments do not). ∗Dept. of Economics, Harvard University. Contact: [email protected]. I thank Dan Burghart, Adam Brandenburger, Paul Glimcher, Drew Fudenberg, Oliver Hart, Yuichiro Kamada, David Laibson, Aurélie Ouss, David Rand, Al Roth, Tomasz Strazlecki, Ryan Webb, and the participants of the Harvard Economics Theory Lunch for incredibly helpful advice and comments on this project. I thank anonymous referees whose comments have greatly improved both the focus and quality of this paper. All errors can be blamed on the lack of enforceable commitment mechanisms.