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Learning, belief manipulation and optimal relationship termination

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  • Gao, Hong
  • Xu, Haibo

Abstract

We study a dynamic agency problem in which a principal and an agent interact on a project repeatedly with the agent’s ability initially unknown to both players. Because an incompetent agent generates successes less frequently and thereby needs to be rewarded more generously for his successes, the agent has attempts to “play dumb” by shirking deliberately. We show that the principal can incentivize the agent by resorting to a combination of wage payments and relationship termination. In equilibrium, relationship termination is introduced in the contracts only when the players’ assessment about the agent’s ability is above a threshold. As a result, the dynamic agency cost presents a non-monotonic relationship with the agent’s ability.

Suggested Citation

  • Gao, Hong & Xu, Haibo, 2020. "Learning, belief manipulation and optimal relationship termination," Economics Letters, Elsevier, vol. 190(C).
    • Handle: RePEc:eee:ecolet:v:190:y:2020:i:c:s0165176520300951
    DOI: 10.1016/j.econlet.2020.109108
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    References listed on IDEAS

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    More about this item

    Keywords

    Hidden action; Hidden information; Belief manipulation; Relationship termination;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness

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