When hidden commitment strength cannot improve a contract

A contract does not necessarily eliminate the temptation to walk away. In Hongcheng Li’s theoretical study, the party offering a contract—the “principal”—may later renege if an alternative option becomes sufficiently attractive. A stronger temptation means weaker commitment power.

The paper asks what happens when that temptation is private information. The other contracting party cannot directly tell how committed the principal really is.

Why hidden strength loses its value

The analysis uses the Intuitive Criterion, a rule that restricts what others can reasonably believe after observing an unexpected action outside the predicted pattern of play. Under this restriction, Li finds that every principal type behaves and receives payoffs as though everyone knew she had the least commitment power.

That does not mean commitment is inherently worthless. The abstract explicitly says it can be valuable when both parties know its strength. The finding concerns the disadvantage of keeping that strength hidden: stronger private commitment does not translate into better contracting outcomes.

Improving the weakest case

Within the model, measures taken before contracting to reduce this information problem have value only if they improve the worst case.

An application considers credit ratings. When a rating system’s cost increases with its number of grades, the optimal system groups issuers into ordered bands. Each issuer then contracts on terms justified by the bottom of her band, rather than her individual position within it.

This is an arXiv preprint, with the supplied version posted on November 6, 2026. This briefing uses only its abstract, which does not provide the full assumptions or proofs. The result is a theoretical conclusion, not reported evidence that all real-world contracts or rating systems behave this way.