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Dynamic costs and moral hazard: A duality-based approach

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  • Arie, Guy
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    The marginal cost of effort often increases as effort is exerted. In a dynamic moral hazard setting, dynamically increasing costs create information asymmetry. This paper characterizes the optimal contract and helps explain the popular yet thus far puzzling use of non-linear incentives, for example, in sales-force compensation. The result is obtained by complementing the standard dynamic program with a novel dynamic dual formulation. The dual program is monotonic and sub-modular, providing stronger results, including a proof for the sufficiency of one-shot deviations.

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    File URL: http://www.sciencedirect.com/science/article/pii/S0022053116300539
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    Article provided by Elsevier in its journal Journal of Economic Theory.

    Volume (Year): 166 (2016)
    Issue (Month): C ()
    Pages: 1-50

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    Handle: RePEc:eee:jetheo:v:166:y:2016:i:c:p:1-50
    DOI: 10.1016/j.jet.2016.08.002
    Contact details of provider: Web page: http://www.elsevier.com/locate/inca/622869

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    1. J. Gabriel & Raquiel López-Martínez & Onésimo Hernández-Lerma, 2001. "The lagrange approach to infinite linear programs," TOP: An Official Journal of the Spanish Society of Statistics and Operations Research, Springer;Sociedad de Estadística e Investigación Operativa, vol. 9(2), pages 293-314, December.
    2. Canice Prendergast, 1999. "The Provision of Incentives in Firms," Journal of Economic Literature, American Economic Association, vol. 37(1), pages 7-63, March.
    3. Ramon Marimon, 2011. "New Results in Recursive Contract Theory," 2011 Meeting Papers 752, Society for Economic Dynamics.
    4. Noah Williams, 2011. "Persistent Private Information," Econometrica, Econometric Society, vol. 79(4), pages 1233-1275, 07.
    5. Albert Marcet & Ramon Marimon, 1994. "Recursive contracts," Economics Working Papers 337, Department of Economics and Business, Universitat Pompeu Fabra, revised Oct 1998.
    6. Bhaskar, Venkataraman, 2014. "The Ratchet Effect Re-examined: A Learning Perspective," CEPR Discussion Papers 9956, C.E.P.R. Discussion Papers.
    7. Gian Luca Clementi & Hugo A. Hopenhayn, 2006. "A Theory of Financing Constraints and Firm Dynamics," The Quarterly Journal of Economics, Oxford University Press, vol. 121(1), pages 229-265.
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