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Deterministic versus stochastic contracts in a dynamic principal-agent model

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  • Thomas Schacherer

    (Humboldt-Universität zu Berlin)

Abstract

This paper studies stochastic dynamic contracting between a principal and an agent, whose type evolution follows a Markov process. I analyze contracts in which the agent can terminate the contract in every period whereas the principal has full-commitment to her offer. The principal tries to screen the true type of the agent to maximize her profit. Therefore, she wants to incentivize him to reveal his true type. I show that stochastic contracts can never bring about more profits than deterministic contracts for the principal if the first-order approach is valid. For this result, it is immaterial if stochastic contracts depend on earlier realizations of the contract or not.

Suggested Citation

  • Thomas Schacherer, 2015. "Deterministic versus stochastic contracts in a dynamic principal-agent model," BDPEMS Working Papers 2015013, Berlin School of Economics.
    • Handle: RePEc:bdp:wpaper:2015013
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    References listed on IDEAS

    as
    1. Strausz, Roland, 2006. "Deterministic versus stochastic mechanisms in principal-agent models," Journal of Economic Theory, Elsevier, vol. 128(1), pages 306-314, May.
    2. Rogerson, William P, 1985. "The First-Order Approach to Principal-Agent Problems," Econometrica, Econometric Society, vol. 53(6), pages 1357-1367, November.
    3. Baron, David P. & Besanko, David, 1984. "Regulation and information in a continuing relationship," Information Economics and Policy, Elsevier, vol. 1(3), pages 267-302.
    4. Marco Battaglini, 2005. "Long-Term Contracting with Markovian Consumers," American Economic Review, American Economic Association, vol. 95(3), pages 637-658, June.
    5. Alessandro Pavan & Ilya Segal & Juuso Toikka, 2014. "Dynamic Mechanism Design: A Myersonian Approach," Econometrica, Econometric Society, vol. 82(2), pages 601-653, March.
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    JEL classification:

    • J - Labor and Demographic Economics

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