The paper presents a dynamic contracting model of myopic firm behaviour caused by the fear of early project termination by outside investors. Although the parties can conclude longterm contracts, asymmetric information between investors and firms can make it impossible to implement profitable long-term projects. The paper characterizes the structure of optimal, renegotiation-proof contracts for unmonitored and monitored finance. Monitoring by investors, although itself subject to distorting incentive constraints, is shown to be able to overcome the short-term bias of investment and thus to lengthen the firms' planning horizon.

We study the problem of financial contracting and renegotiation between a firm and outside investors when the firm cannot commit to future payouts, but assets can be contracted upon. We show that a capital structure with multiple investors specializing in short-term and long-term claims is superior to a structure with only one type of claim, because this hardens the incentives for the entrepreneur to renegotiate the contract ex post. Depending on the parameters, the optimal capital structure also differentiates between state-independent and state-dependent longterm claims, which can be interpreted as long-term debt and equity.

The paper introduces the problem of unawareness into principal–agent theory and discusses optimal incentive contracts when the agent may be unaware of her action space. Depending on the agent's default behaviour, it can be optimal for the principal to propose an incomplete contract (that keeps the agent unaware) or a complete contract. The key trade-off is that of enlarging the agent's choice set versus adding costly incentive constraints. If agents differ in their unawareness, optimal contracts show a self-reinforcing pattern: if there are few unaware agents in the economy optimal contracts promote awareness, if unawareness is wide spread optimal contracts shroud the contracting environment, thus keeping the agent unaware.