Relational contracts when the agent's productivity inside the relationship is correlated with outside opportunities
AbstractAn agent can choose to bear personal costs to the principal's benefit. In return, the principal offers rewards. If this exchange is not contractible, typically repeated interaction will be required to sustain it. The novel feature of the analysis is that the agent's productivity inside the relationship is correlated with productivity outside. The paper derives the implications of this arguably realistic assumption for the feasibility of relational contracts and for agent selection by principals. It shows, for example, that optimal agent productivity is often non-monotonic in the importance, to the principal, of ensuring agent reliability. Applications of this framework in labor, management, and politics help organize some stylized facts.
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Date of creation: May 2011
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