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Implications of Unequal Discounting in Dynamic Contracting

Author

Listed:
  • Ilia Krasikov
  • Rohit Lamba
  • Thomas Mettral

Abstract

This paper studies a canonical dynamic screening problem where the agent has Markovian private information and limited commitment and the principal and the agent have different discount factors. Unequal discounting captures unequal access to capital markets. In comparison to standard models of dynamic mechanism design, the principal no longer finds it optimal to maximally back-load the agent's information rents: a new force of intertemporal cost of incentive provision pushes toward front-loading agents' payoffs. The optimal contract settles into a cycle with infinite memory. The introduction of unequal discounting renders the standard relaxed-problem approach invalid for certain parameters. A simple and approximately optimal contract is then provided.

Suggested Citation

  • Ilia Krasikov & Rohit Lamba & Thomas Mettral, 2023. "Implications of Unequal Discounting in Dynamic Contracting," American Economic Journal: Microeconomics, American Economic Association, vol. 15(1), pages 638-692, February.
    • Handle: RePEc:aea:aejmic:v:15:y:2023:i:1:p:638-92
    DOI: 10.1257/mic.20200427
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    More about this item

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation

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