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The curse of long horizons

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  • Bhaskar, V.
  • Mailath, George J.

Abstract

We study dynamic moral hazard when the principal can only commit to spot contracts. The principal and agent are ex ante symmetrically uncertain about the difficulty of the job, and update their beliefs upon observing output. Since the agent’s effort is private, he has an additional incentive to shirk when the principal induces effort: shirking results in the principal having incorrect beliefs, giving rise to future informational rents. We show that the effort-inducing contract must provide increasingly high-powered incentives as the length of the relationship increases. Thus it is never optimal to always induce effort in very long relationships.

Suggested Citation

  • Bhaskar, V. & Mailath, George J., 2019. "The curse of long horizons," Journal of Mathematical Economics, Elsevier, vol. 82(C), pages 74-89.
    • Handle: RePEc:eee:mateco:v:82:y:2019:i:c:p:74-89
    DOI: 10.1016/j.jmateco.2019.01.009
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    Cited by:

    1. Bhaskar, V. & Mailath, George J., 2019. "The curse of long horizons," Journal of Mathematical Economics, Elsevier, vol. 82(C), pages 74-89.
    2. Johannes Abeler & David Huffman & Collin Raymond & David B. Huffman, 2023. "Incentive Complexity, Bounded Rationality and Effort Provision," CESifo Working Paper Series 10541, CESifo.
    3. Cetemen, Doruk & Hwang, Ilwoo & Kaya, Ayça, 2020. "Uncertainty-driven cooperation," Theoretical Economics, Econometric Society, vol. 15(3), July.
    4. Gao, Hong & Xu, Haibo, 2020. "Learning, belief manipulation and optimal relationship termination," Economics Letters, Elsevier, vol. 190(C).
    5. Abeler, Johannes & Huffman, David B. & Raymond, Collin, 2023. "Incentive Complexity, Bounded Rationality and Effort Provision," IZA Discussion Papers 16284, Institute of Labor Economics (IZA).
    6. Bhaskar, V & Roketskiy, Nikita, 2023. "The ratchet effect: A learning perspective," Journal of Economic Theory, Elsevier, vol. 214(C).
    7. Ekmekci, Mehmet & Maestri, Lucas, 2019. "Reputation and screening in a noisy environment with irreversible actions," MPRA Paper 100885, University Library of Munich, Germany.

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    More about this item

    Keywords

    Principal-agency; Moral hazard; Differences in beliefs; High-powered incentives;
    All these keywords.

    JEL classification:

    • D01 - Microeconomics - - General - - - Microeconomic Behavior: Underlying Principles
    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • J30 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - General

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