# me with a and b Consider an investor who is able to choose between investing 8 million \$ or not to invest at all, in

me with a and b Consider an investor who is able to choose between investing 8 million \$ or not to invest at
all, in a project that is carried out by an entrepreneur. The entrepreneur can then either
cooperate, resulting in a net profit of 4 million \$ for each party, or appropriate the investment
in which case the investor looses all the money to the entrepreneur. When the investor does
not invest the profit is zero for both agents.
The game looks as follows:
Agent
cooperate
appropriate
Invest
4.4
-8 , 8
Principal
Don’t invest
0,0
0,0
a) Assume that the principal has the oppurtunity to choose if to invest or not before the agent
chooses his performance. Draw the extensive form game and find the subgame perfect
equilibrium. Will the equilibrium be Pareto efficient? Will the outcome of the game be
cooperative?
b) Suppose that an enforceable contract gives the investor compensation from the agent
amounting to the investment plus the expected profit foregone in case of
breach/appropriation. (Perfect expectation damages in C&U) Write down this new extensive
form game and find the subgame perfect equilibrium. Will the outcome of the game be Pareto
efficient?
c) Suppose that there is uncertainty regarding the cost of carrying out the contract
at the time of signing it. The entrepreneur can incur a cost of either zero or 10. Will
perfect expectation damages lead to an efficient incentive for breach in this case?

(550 words)

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