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Contracting with Repeated Moral Hazard and Private Evaluations

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Author Info
William Fuchs

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Abstract

A repeated moral hazard setting in which the Principal privately observes the Agent's output is studied. The optimal contract for a finite horizon is characterized, and shown to require burning of resources. These are only burnt after the worst possible realization sequence and the amount is independent of both the length of the horizon and the discount factor. For the infinite horizon. it is shown that there is no loss from restricting the analysis to contracts in which the Agent receives a constant efficiency wage and no feedback until he is fired. Furthermore, optimal contracts cannot be replicated by short-term contracts. A family of fixed interval review contracts is characterized. Longer review intervals are preferable but harder to implement. Comparative statics on the review length are carried out. Finally, these contracts are shown approximate first best if players are very patient. (JEL D82, D86)

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File URL: http://hdl.handle.net/10.1257/aer.97.4.1432
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Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 97 (2007)
Issue (Month): 4 (September)
Pages: 1432-1448
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Handle: RePEc:aea:aecrev:v:97:y:2007:i:4:p:1432-1448

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Kandori, Michihiro, 2002. "Introduction to Repeated Games with Private Monitoring," Journal of Economic Theory, Elsevier, vol. 102(1), pages 1-15, January. [Downloadable!] (restricted)
  2. Edward P. Lazear & Sherwin Rosen, 1981. "Rank-Order Tournaments as Optimum Labor Contracts," NBER Working Papers 0401, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  3. Malcomson, James M, 1984. "Work Incentives, Hierarchy, and Internal Labor Markets," Journal of Political Economy, University of Chicago Press, vol. 92(3), pages 486-507, June. [Downloadable!] (restricted)
  4. Baker, George P, 1992. "Incentive Contracts and Performance Measurement," Journal of Political Economy, University of Chicago Press, vol. 100(3), pages 598-614, June. [Downloadable!] (restricted)
  5. Radner, Roy, 1985. "Repeated Principal-Agent Games with Discounting," Econometrica, Econometric Society, vol. 53(5), pages 1173-98, September. [Downloadable!] (restricted)
  6. Michihiro Kandori & Hitoshi Matsushima, 1998. "Private Observation, Communication and Collusion," Econometrica, Econometric Society, vol. 66(3), pages 627-652, May.
  7. Fehr, Ernst & Falk, Armin, 2002. "Psychological Foundations of Incentives," IZA Discussion Papers 507, Institute for the Study of Labor (IZA). [Downloadable!]
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  8. Shapiro, Carl & Stiglitz, Joseph E, 1984. "Equilibrium Unemployment as a Worker Discipline Device," American Economic Review, American Economic Association, vol. 74(3), pages 433-44, June. [Downloadable!] (restricted)
  9. Abreu, Dilip & Milgrom, Paul & Pearce, David, 1991. "Information and Timing in Repeated Partnerships," Econometrica, Econometric Society, vol. 59(6), pages 1713-33, November. [Downloadable!] (restricted)
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  10. Rosen, Sherwin, 1986. "Prizes and Incentives in Elimination Tournaments," American Economic Review, American Economic Association, vol. 76(4), pages 701-15, September. [Downloadable!] (restricted)
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  11. Compte, Olivier, 2002. "On Sustaining Cooperation without Public Observations," Journal of Economic Theory, Elsevier, vol. 102(1), pages 106-150, January. [Downloadable!] (restricted)
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  14. Baker, George & Gibbons, Robert & Murphy, Kevin J, 1994. "Subjective Performance Measures in Optimal Incentive Contracts," The Quarterly Journal of Economics, MIT Press, vol. 109(4), pages 1125-56, November. [Downloadable!] (restricted)
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  15. Jonathan Levin, 2003. "Relational Incentive Contracts," American Economic Review, American Economic Association, vol. 93(3), pages 835-857, June. [Downloadable!]
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  16. Kahn, Charles & Mookherjee, Dilip, 1988. "A Competitive Efficiency Wage Model with Keynesian Features," The Quarterly Journal of Economics, MIT Press, vol. 103(4), pages 609-45, November. [Downloadable!] (restricted)
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  22. Massimiliano Amarante, 2003. "Recursive structure and equilibria in games with private monitoring," Economic Theory, Springer, vol. 22(2), pages 353-374, 09. [Downloadable!] (restricted)
  23. Holmstrom, Bengt & Milgrom, Paul, 1991. "Multitask Principal-Agent Analyses: Incentive Contracts, Asset Ownership, and Job Design," Journal of Law, Economics and Organization, Oxford University Press, vol. 7(0), pages 24-52, Special I.
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  25. Garvey, Gerald T., 1995. "Why reputation favors joint ventures over vertical and horizontal integration A simple model," Journal of Economic Behavior & Organization, Elsevier, vol. 28(3), pages 387-397, December. [Downloadable!] (restricted)
  26. Canice Prendergast, 1999. "The Provision of Incentives in Firms," Journal of Economic Literature, American Economic Association, vol. 37(1), pages 7-63, March. [Downloadable!] (restricted)
  27. MacLeod, W Bentley & Malcomson, James M, 1989. "Implicit Contracts, Incentive Compatibility, and Involuntary Unemployment," Econometrica, Econometric Society, vol. 57(2), pages 447-80, March. [Downloadable!] (restricted)
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  28. W. Bentley MacLeod & Daniel Parent, 1998. "Job Characteristics and the Form of Compensation," CIRANO Working Papers 98s-08, CIRANO. [Downloadable!]
  29. Yeon-Koo Che & Seung-Weon Yoo, 2001. "Optimal Incentives for Teams," American Economic Review, American Economic Association, vol. 91(3), pages 525-541, June. [Downloadable!] (restricted)
  30. Brown, Martin & Falk, Armin & Fehr, Ernst, 2002. "Contractual Incompleteness and the Nature of Market Interactions," CEPR Discussion Papers 3272, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  31. Edward P. Lazear, 1999. "Output-based Pay: Incentives or Sorting?," NBER Working Papers 7419, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  32. Jonathan Levin, 2002. "Multilateral Contracting And The Employment Relationship," The Quarterly Journal of Economics, MIT Press, vol. 117(3), pages 1075-1103, August. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Crémer, Jacques & Khalil, Fahad, 1991. "Gathering Information before Signing a Contract," IDEI Working Papers 5, Institut d'Économie Industrielle (IDEI), Toulouse. [Downloadable!]
    Other versions:
  2. Anton Suvorov & Jeroen van de Ven, 2006. "Discretionary Bonuses as a Feedback Mechanism," Working Papers w0088, Center for Economic and Financial Research (CEFIR). [Downloadable!]
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