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Disagreement and Learning in a Dynamic Contracting Model

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  • Tobias Adrian
  • Mark M. Westerfield

Abstract

We present a dynamic contracting model in which the principal and agent disagree about the resolution of uncertainty, and we illustrate the contract design in an application with Bayesian learning. The disagreement creates gains from trade that the principal realizes by transferring payment to states that the agent considers relatively more likely, changing incentives. The interaction between incentive provision and learning creates an intertemporal source of "disagreement risk" that alters optimal risk sharing. There is an endogenous regime shift between economies with small and large belief differences, and an early shock to beliefs can lead to large persistent differences in variable pay even after beliefs have converged. Under risk-neutrality, "selling the firm" to the agent does not implement the first-best because it precludes state-contingent trades. The Author 2009. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org, Oxford University Press.

Suggested Citation

  • Tobias Adrian & Mark M. Westerfield, 2009. "Disagreement and Learning in a Dynamic Contracting Model," Review of Financial Studies, Society for Financial Studies, vol. 22(10), pages 3873-3906, October.
  • Handle: RePEc:oup:rfinst:v:22:y:2009:i:10:p:3873-3906
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    References listed on IDEAS

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    Cited by:

    1. Giat, Yahel & Subramanian, Ajay, 2013. "Dynamic contracting under imperfect public information and asymmetric beliefs," Journal of Economic Dynamics and Control, Elsevier, vol. 37(12), pages 2833-2861.
    2. Anja Sautmann, 2013. "Contracts for Agents with Biased Beliefs: Some Theory and an Experiment," American Economic Journal: Microeconomics, American Economic Association, vol. 5(3), pages 124-156, August.
    3. Zhiguo He & Bin Wei & Jianfeng Yu & Feng Gao, 2017. "Optimal Long-Term Contracting with Learning," Review of Financial Studies, Society for Financial Studies, vol. 30(6), pages 2006-2065.
    4. Prat, Julien & Jovanovic, Boyan, 2014. "Dynamic contracts when agent's quality is unknown," Theoretical Economics, Econometric Society, vol. 9(3), September.
    5. Leonidas Enrique De La Rosa, 2008. "Overconfidence in a Career-Concerns Setting," CESifo Working Paper Series 2405, CESifo Group Munich.
    6. Duane Windsor, 2010. "The Role of Dynamics in Stakeholder Thinking," Journal of Business Ethics, Springer, vol. 96(1), pages 79-87, August.
    7. Marie-Louise Vierø, 2012. "Contracting in Vague Environments," American Economic Journal: Microeconomics, American Economic Association, vol. 4(2), pages 104-130, May.
    8. Thibaut Mastrolia & Dylan Possamai, 2015. "Moral hazard under ambiguity," Papers 1511.03616, arXiv.org, revised Oct 2016.
    9. Rajiv Sethi & Muhamet Yildiz, 2012. "Public Disagreement," American Economic Journal: Microeconomics, American Economic Association, vol. 4(3), pages 57-95, August.
    10. Hae Won (Henny) Jung & Ajay Subramanian, 2014. "Capital Structure under Heterogeneous Beliefs," Review of Finance, European Finance Association, vol. 18(5), pages 1617-1681.
    11. Botond Koszegi & Peter Kondor, 2015. "Cursed financial innovation," 2015 Meeting Papers 1098, Society for Economic Dynamics.
    12. repec:spr:joptap:v::y::i::d:10.1007_s10957-018-1230-8 is not listed on IDEAS
    13. de la Rosa, Leonidas Enrique, 2011. "Overconfidence and moral hazard," Games and Economic Behavior, Elsevier, vol. 73(2), pages 429-451.

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