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Disagreement and learning in a dynamic contracting model

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  • Tobias Adrian
  • Mark M. Westerfield

Abstract

The authors present a dynamic contracting model in which the principal and the agent disagree about the resolution of uncertainty, and they 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, a shift that changes incentives. In their dynamic setting, the interaction between incentive provision and learning creates an intertemporal source of “disagreement risk” that alters optimal risk sharing. An endogenous regime shift between economies with small and large belief differences is present, 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 outcome because it precludes state-contingent trades.

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Bibliographic Info

Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 269.

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Date of creation: 2008
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Handle: RePEc:fip:fednsr:269

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Keywords: Contracts ; Uncertainty ; Econometric models ; Microeconomics;

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References

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  1. Dirk Jenter, 2005. "Market Timing and Managerial Portfolio Decisions," Journal of Finance, American Finance Association, vol. 60(4), pages 1903-1949, 08.
  2. Paul Milgrom & Nancy L.Stokey, 1979. "Information, Trade, and Common Knowledge," Discussion Papers 377R, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  3. Takatoshi Ito, 1988. "Foreign Exchange Rate Expectations: Micro Survey Data," NBER Working Papers 2679, National Bureau of Economic Research, Inc.
  4. Holmstrom, Bengt & Milgrom, Paul, 1987. "Aggregation and Linearity in the Provision of Intertemporal Incentives," Econometrica, Econometric Society, vol. 55(2), pages 303-28, March.
  5. Daron Acemoglu & Victor Chernozhukov & Muhamet Yildiz, 2007. "Learning and Disagreement in an Uncertain World," Carlo Alberto Notebooks 48, Collegio Carlo Alberto.
  6. Terrance Odean, 1999. "Do Investors Trade Too Much?," American Economic Review, American Economic Association, vol. 89(5), pages 1279-1298, December.
  7. Muhamet Yildiz, 2003. "Bargaining without a Common Prior-An Immediate Agreement Theorem," Econometrica, Econometric Society, vol. 71(3), pages 793-811, 05.
  8. 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.
  9. Noah Williams, 2004. "On Dynamic Principal-Agent Problems in Continuous Time," Levine's Bibliography 122247000000000426, UCLA Department of Economics.
  10. Malcolm Baker & Richard S. Ruback & Jeffrey Wurgler, 2004. "Behavioral Corporate Finance: A Survey," NBER Working Papers 10863, National Bureau of Economic Research, Inc.
  11. Itzhak Ben-David & John R. Graham & Campbell R. Harvey, 2007. "Managerial Overconfidence and Corporate Policies," NBER Working Papers 13711, National Bureau of Economic Research, Inc.
  12. Sendhil Mullainathan & Richard H. Thaler, 2000. "Behavioral Economics," NBER Working Papers 7948, National Bureau of Economic Research, Inc.
  13. Robert J Aumann, 1999. "Agreeing to Disagree," Levine's Working Paper Archive 512, David K. Levine.
  14. Roland Bénabou & Jean Tirole, 2002. "Self-Confidence And Personal Motivation," The Quarterly Journal of Economics, MIT Press, vol. 117(3), pages 871-915, August.
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Citations

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Cited by:
  1. Marie-Louise Vierø, 2006. "Contracting in Vague Environments," Working Papers 1106, Queen's University, Department of Economics.
  2. Prat, Julien & Jovanovic, Boyan, 2010. "Dynamic Incentive Contracts under Parameter Uncertainty," IZA Discussion Papers 5323, Institute for the Study of Labor (IZA).
  3. Rajiv Sethi & Muhamet Yildiz, 2012. "Public Disagreement," American Economic Journal: Microeconomics, American Economic Association, vol. 4(3), pages 57-95, August.
  4. Leonidas Enrique De La Rosa, 2008. "Overconfidence in a Career-Concerns Setting," CESifo Working Paper Series 2405, CESifo Group Munich.
  5. Anja Sautmann, 2013. "Contracts for Agents with Biased Beliefs: Some Theory and an Experiment," American Economic Journal: Microeconomics, American Economic Association, vol. 5(3), pages 124-56, August.
  6. Jianfeng Yu & Bin Wei & Zhiguo He, 2012. "Optimal Long-term Contracting with Learning," 2012 Meeting Papers 221, Society for Economic Dynamics.
  7. Giat, Yahel & Subramanian, Ajay, 2013. "Dynamic contracting under imperfect public information and asymmetric beliefs," Journal of Economic Dynamics and Control, Elsevier, vol. 37(12), pages 2833-2861.
  8. Jovanovic, Boyan & Prat, Julien, 0. "Dynamic contracts when agent'’s quality is unknown," Theoretical Economics, Econometric Society.
  9. Duane Windsor, 2010. "The Role of Dynamics in Stakeholder Thinking," Journal of Business Ethics, Springer, vol. 96(1), pages 79-87, August.

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