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A Theory of Threshold Contracts

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We consider an in nitely repeated reappointment game in a principal- agent relationship. Typical examples are voter-politician or government- public servant relationships. The agent chooses costly effort and enjoys being in office until he is deselected. The principal observes a noisy signal of the agent's effort and decides whether to reappoint the agent or not. We analyse the stationary Markovian equilibria of this game and examine the consequences of threshold contracts, which forbid reappointment if the principal's utility is too low. We identify the circumstances under which such threshold contracts are welfare-improving or beneficial for the principal.

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File URL: http://www.cer.ethz.ch/research/WP-13-182.pdf
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Paper provided by CER-ETH - Center of Economic Research (CER-ETH) at ETH Zurich in its series CER-ETH Economics working paper series with number 13/182.

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Length: 62 pages
Date of creation: Oct 2013
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Handle: RePEc:eth:wpswif:13-182

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Keywords: principal-agent model; repeated game; reappointment; stationary Markovian strategies; threshold strategies; threshold contracts; asymmetric information; commitment.;

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  1. John Ferejohn, 1986. "Incumbent performance and electoral control," Public Choice, Springer, vol. 50(1), pages 5-25, January.
  2. Gersbach, Hans & Liessem, Verena, 2005. "Re-election Threshold Contracts in Politics," CEPR Discussion Papers 5175, C.E.P.R. Discussion Papers.
  3. Gersbach, Hans, 2008. "Contractual Democracy," CEPR Discussion Papers 6763, C.E.P.R. Discussion Papers.
  4. Patrick Bolton & Mathias Dewatripont, 2005. "Contract Theory," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262025760, December.
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