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Incentives to Invest in Short-Term vs Long-Term Contracts: Theory and Evidence

Author

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  • Dubois Pierre

    (Toulouse School of Economics, UT 1 Capitole, Toulouse, France)

  • Vukina Tomislav

    (Department of Agricultural and Resource Economics, North Carolina State University, Raleigh, North Carolina 27695-8109, United States of America)

Abstract

We study the effects of the change in contract length on the agents’ incentives to invest and exert effort. We present an agent’s dynamic decision model that explicitly deals with two types of investments and directly allows for contract regime switching by varying the probability of contract renewal. The fact that the unobservable investment in human capital is complementary with the agent’s effort produces a result that increasing the probability of contract renewal increases investment and effort, with the consequent increase in production. We also show that there exists a specific level of investment in human capital, for which the investment in physical capital is profitable. We test these theoretical predictions using contract settlement data for the production of hatching eggs which covers the period when the contract changed from short-term to long-term. The obtained empirical results are largely supportive of the developed theory.

Suggested Citation

  • Dubois Pierre & Vukina Tomislav, 2016. "Incentives to Invest in Short-Term vs Long-Term Contracts: Theory and Evidence," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 16(3), pages 1239-1272, September.
    • Handle: RePEc:bpj:bejeap:v:16:y:2016:i:3:p:1239-1272:n:15
    DOI: 10.1515/bejeap-2016-0026
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    References listed on IDEAS

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