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Relational contracts, limited liability, and employment dynamics

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  • Fong, Yuk-fai
  • Li, Jin

Abstract

This paper studies a relational contracting model in which the agent is protected by a limited liability constraint. The agent's effort is his private information and affects output stochastically. We characterize the optimal relational contract and compare the dynamics of the relationship with that under the optimal long-term contract. Under the optimal relational contract, the relationship is less likely to survive, and the surviving relationship is less efficient. In addition, relationships always converge to a steady state under the optimal long-term contract, but they can cycle among different phases under the optimal relational contract.

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  • Fong, Yuk-fai & Li, Jin, 2017. "Relational contracts, limited liability, and employment dynamics," Journal of Economic Theory, Elsevier, vol. 169(C), pages 270-293.
  • Handle: RePEc:eee:jetheo:v:169:y:2017:i:c:p:270-293
    DOI: 10.1016/j.jet.2017.02.006
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    3. Lipnowski, Elliot & Ramos, João, 2020. "Repeated delegation," Journal of Economic Theory, Elsevier, vol. 188(C).
    4. Szydlowski, Martin & Yoon, Ji Hee, 2022. "Ambiguity in dynamic contracts," Journal of Economic Theory, Elsevier, vol. 199(C).
    5. Florian Englmaier & Matthias Fahn & Marco A. Schwarz, 2016. "Long-Term Employment Relations when Agents are Present Biased," CESifo Working Paper Series 6159, CESifo.
    6. Thomas, Jonathan P. & Worrall, Tim, 2018. "Dynamic relational contracts under complete information," Journal of Economic Theory, Elsevier, vol. 175(C), pages 624-651.
    7. Matthias Fahn & Anne Schade & Katharina Schüßler, 2017. "What Drives Reciprocal Behavior? The Optimal Provision of Incentives over the Course of Careers," CESifo Working Paper Series 6635, CESifo.
    8. Paltseva, Elena & Toews , Gerhard & Troya-Martinez, Marta, 2022. "I’ll pay you later: Sustaining Relationships under the Threat of Expropriation," SITE Working Paper Series 59, Stockholm School of Economics, Stockholm Institute of Transition Economics.
    9. Daniel Barron & Yingni Guo, 0. "The Use and Misuse of Coordinated Punishments," The Quarterly Journal of Economics, Oxford University Press, vol. 136(1), pages 471-504.
    10. Grochulski, Borys & Zhang, Yuzhe, 0. "Termination as an incentive device," Theoretical Economics, Econometric Society.
    11. Au, Pak Hung & Chen, Bin R., 2019. "Objective and subjective indicators in long-term contracting," Journal of Economic Behavior & Organization, Elsevier, vol. 166(C), pages 309-331.

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    More about this item

    Keywords

    Relational contracts; Limited liability; Efficiency wages;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
    • L24 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Contracting Out; Joint Ventures

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