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Disagreement and Learning in a Dynamic Contracting Model

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Author Info
Tobias Adrian
Mark M. Westerfield

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Abstract

We present a dynamic contracting model in which the principal and agent disagree about the resolution of uncertainty, and we illustrate the contract design in an application with Bayesian learning. The disagreement creates gains from trade that the principal realizes by transferring payment to states that the agent considers relatively more likely, changing incentives. The interaction between incentive provision and learning creates an intertemporal source of "disagreement risk" that alters optimal risk sharing. There is an endogenous regime shift between economies with small and large belief differences, and an early shock to beliefs can lead to large persistent differences in variable pay even after beliefs have converged. Under risk-neutrality, "selling the firm" to the agent does not implement the first-best because it precludes state-contingent trades. The Author 2009. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org, Oxford University Press.

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File URL: http://hdl.handle.net/10.1093/rfs/hhn115
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Publisher Info
Article provided by Oxford University Press for Society for Financial Studies in its journal The Review of Financial Studies.

Volume (Year): 22 (2009)
Issue (Month): 10 (October)
Pages: 3873-3906
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Handle: RePEc:oup:rfinst:v:22:y:2009:i:10:p:3873-3906

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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. Sendhil Mullainathan & Richard H. Thaler, 2000. "Behavioral Economics," NBER Working Papers 7948, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  2. Holmstrom, Bengt & Milgrom, Paul, 1987. "Aggregation and Linearity in the Provision of Intertemporal Incentives," Econometrica, Econometric Society, vol. 55(2), pages 303-28, March. [Downloadable!] (restricted)
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  3. Roland Bénabou & Jean Tirole, 2002. "Self-Confidence And Personal Motivation," The Quarterly Journal of Economics, MIT Press, vol. 117(3), pages 871-915, August. [Downloadable!] (restricted)
  4. Takatoshi Ito, 1990. "Foreign Exchange Rate Expectations: Micro Survey Data," NBER Working Papers 2679, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  5. Milgrom, Paul & Stokey, Nancy, 1982. "Information, trade and common knowledge," Journal of Economic Theory, Elsevier, vol. 26(1), pages 17-27, February. [Downloadable!] (restricted)
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  6. Muhamet Yildiz, 2003. "Bargaining without a Common Prior-An Immediate Agreement Theorem," Econometrica, Econometric Society, vol. 71(3), pages 793-811, 05. [Downloadable!] (restricted)
  7. Ross, Stephen A, 1973. "The Economic Theory of Agency: The Principal's Problem," American Economic Review, American Economic Association, vol. 63(2), pages 134-39, May. [Downloadable!] (restricted)
  8. Noah Williams, 2004. "On Dynamic Principal-Agent Problems in Continuous Time," Levine's Bibliography 122247000000000426, UCLA Department of Economics. [Downloadable!]
  9. Terrance Odean, 1999. "Do Investors Trade Too Much?," American Economic Review, American Economic Association, vol. 89(5), pages 1279-1298, December. [Downloadable!] (restricted)
  10. Bengt Holmstrom, 1979. "Moral Hazard and Observability," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 74-91, Spring. [Downloadable!] (restricted)
  11. Malcolm Baker & Richard S. Ruback & Jeffrey Wurgler, 2004. "Behavioral Corporate Finance: A Survey," NBER Working Papers 10863, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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Cited by:
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  1. Rajiv Sethi & Muhamet Yildiz, 2009. "Public Disagreement," Economics Working Papers 0089, Institute for Advanced Study, School of Social Science. [Downloadable!]
  2. Leonidas Enrique De La Rosa, 2008. "Overconfidence in a Career-Concerns Setting," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
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