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Production priorities in dynamic relationships

Author

Listed:
  • Forand, Jean Guillaume

    (Department of Economics, University of Waterloo)

  • Zapal, Jan

    (CERGE-EI, a joint workplace of Charles University and the Economics Institute of the Czech Academy of Sciences)

Abstract

We characterise optimal contracts in a dynamic principal-agent model of joint production in which project opportunities are heterogenous, utility from these projects is non-transferable and the agent has the option to quit the relationship at any time. In order to demand the production of projects that benefit her but not the agent, the principal must commit to produce projects that benefit the agent in the future. Production at all stages of the relationship is ordered by projects' cost-effectiveness, which is their efficiency in transferring utility between the principal and the agent: cost-effective demands impose relatively low costs on the agent, and cost-effective compensation imposes relatively low costs on the principal. Over time, optimal contracts become more generous towards the agent by adding commitments to less cost-effective compensation. In turn, because this new compensation cannot be profitably exchanged against less cost-effective demands, the principal narrows the scope of her demands.

Suggested Citation

  • Forand, Jean Guillaume & Zapal, Jan, 2020. "Production priorities in dynamic relationships," Theoretical Economics, Econometric Society, vol. 15(3), July.
    • Handle: RePEc:the:publsh:2963
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    References listed on IDEAS

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    More about this item

    Keywords

    Dynamic contracts; incentive provision; heterogenous projects;
    All these keywords.

    JEL classification:

    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • L24 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Contracting Out; Joint Ventures

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