Financing Multi-stage projects under moral hazard and limited commitment

We present the optimal contract for financing a project that has N stages to be completed sequentially when the principal can not commit to abandone the project before it is completed and the project to be completed is valued by the agent. In a dynamic moral hazard setting, we find that the optimal contract provides decreasing transfers for successive unsuccessful attempts in a given stage, and smaller transfers when the subsequent stages are reached. We find that the optimal sequence of transfers is greater the bigger is the exogenous probability of returning to a preceding stage and the greater the principal’s cost of stage verification is. When intermediate stages are valued by the agent, we find that smaller transfers are optimal.