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The Optimal Duration of Contracts

Author

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  • Panu Poutvaara

    ()

  • Tuomas Takalo
  • Andreas Wagener

Abstract

We study the optimal duration of contracts in a principal-agent framework with both moral hazard and adverse selection. Agents decide on a contract-specific and non-verifiable investment. Incentive compatibility requires that initial contracts, which serve to screen the ability of newly hired agents, cannot be longer than continuation contracts, offered to successful agents. Initial contracts remain unpaid unless service quality is unobservable to other agents and the share of high-ability agents is high. Optimal durations depend, in non-monotonic ways, on the principal’s ow valuation of the agent’s service and the share of high-ability agents.

Suggested Citation

  • Panu Poutvaara & Tuomas Takalo & Andreas Wagener, 2017. "The Optimal Duration of Contracts," CESifo Working Paper Series 6808, CESifo Group Munich.
  • Handle: RePEc:ces:ceswps:_6808
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    File URL: http://www.cesifo-group.de/DocDL/cesifo1_wp6808.pdf
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    References listed on IDEAS

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    Cited by:

    1. Spear, Stephen E. & Wang, Cheng, 2005. "When to fire a CEO: optimal termination in dynamic contracts," Journal of Economic Theory, Elsevier, vol. 120(2), pages 239-256, February.
    2. Katolnik, Svetlana & Hakenes, Hendrik, 2014. "On the Incentive Effect of Job Rotation," Annual Conference 2014 (Hamburg): Evidence-based Economic Policy 100574, Verein für Socialpolitik / German Economic Association.

    More about this item

    Keywords

    contract length; term length; screening;

    JEL classification:

    • J30 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - General
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation
    • J41 - Labor and Demographic Economics - - Particular Labor Markets - - - Labor Contracts
    • D72 - Microeconomics - - Analysis of Collective Decision-Making - - - Political Processes: Rent-seeking, Lobbying, Elections, Legislatures, and Voting Behavior

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