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Optimal Self-enforcing and Termination

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  • Cheng Wang

    (Iowa State University)

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    Abstract

    We study a dynamic principal-agent relationship in which the agent receives a stochastic outside opportunity/offer each period and he cannot commit to not leaving the ongoing relationship.Termination, while costly, allows the principal to go to an external market to hire a new agent. We treat self-enforcing as a choice variable by letting the principal respond strategically to the agent's outside offers. Starting initially from a sufficiently low expected utility of the agent (so the commitment constraint is binding, initially), the continuation of the optimal contract converges to Burdett (1978) where each period the agent quits whenever his outside offer is above the utility the current principal offers, and he stays to receive the same constant expected utility otherwise. On the path of convergence, termination occurs whenever the agent's outside offer exceeds a constant ceiling, and the principal acts to match the agent's outside offer if it is below that constant ceiling but better than his current promised utility. The convergence is monotonic. Conditional on continuation, over time the agent's expected utility converges monotonically to its limiting level while the commitment constraint binds monotonically less; and the limiting utility of the agent is the lowest level of his expected utility at which the commitment constraint is not binding.

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    Bibliographic Info

    Paper provided by Society for Economic Dynamics in its series 2012 Meeting Papers with number 433.

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    Date of creation: 2012
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    Handle: RePEc:red:sed012:433

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    1. Debraj Ray, 2002. "The Time Structure of Self-Enforcing Agreements," Econometrica, Econometric Society, vol. 70(2), pages 547-582, March.
    2. Narayana Kocherlakota, 2010. "Implications of Efficient Risk Sharing Without Commitment," Levine's Working Paper Archive 2053, David K. Levine.
    3. Mortensen, Dale T & Pissarides, Christopher A, 1994. "Job Creation and Job Destruction in the Theory of Unemployment," Review of Economic Studies, Wiley Blackwell, vol. 61(3), pages 397-415, July.
    4. Thomas, Jonathan & Worrall, Tim, 1988. "Self-enforcing Wage Contracts," Review of Economic Studies, Wiley Blackwell, vol. 55(4), pages 541-54, October.
    5. Spear, Stephen E. & Wang, Cheng, 2005. "When to fire a CEO: optimal termination in dynamic contracts," Journal of Economic Theory, Elsevier, vol. 120(2), pages 239-256, February.
    6. Wang, Cheng, 1995. "Dynamic Insurance with Private Information and Balanced Budgets," Staff General Research Papers 5249, Iowa State University, Department of Economics.
    7. Spear, Stephen E & Srivastava, Sanjay, 1987. "On Repeated Moral Hazard with Discounting," Review of Economic Studies, Wiley Blackwell, vol. 54(4), pages 599-617, October.
    8. Yuliy Sannikov, 2008. "A Continuous-Time Version of the Principal-Agent Problem," Review of Economic Studies, Oxford University Press, vol. 75(3), pages 957-984.
    9. Wang, Cheng, 2011. "Termination of dynamic contracts in an equilibrium labor market model," Journal of Economic Theory, Elsevier, vol. 146(1), pages 74-110, January.
    10. Jovanovic, Boyan, 1984. "Matching, Turnover, and Unemployment," Journal of Political Economy, University of Chicago Press, vol. 92(1), pages 108-22, February.
    11. Peter M. DeMarzo & Michael J. Fishman, 2007. "Optimal Long-Term Financial Contracting," Review of Financial Studies, Society for Financial Studies, vol. 20(6), pages 2079-2128, November.
    12. Giuseppe Moscarini, 2005. "Job Matching and the Wage Distribution," Econometrica, Econometric Society, vol. 73(2), pages 481-516, 03.
    13. Phelan Christopher, 1995. "Repeated Moral Hazard and One-Sided Commitment," Journal of Economic Theory, Elsevier, vol. 66(2), pages 488-506, August.
    14. Wang, Cheng, 1995. "Dynamic Insurance with Private Information and Balanced Budgets," Review of Economic Studies, Wiley Blackwell, vol. 62(4), pages 577-95, October.
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