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The Curse of Long Horizons

Author

Listed:
  • Venkataraman Bhaskar

    (Department of Economics, University of Texas)

  • George Mailath

    (Department of Economics, University of Pennsylvania)

Abstract

We study dynamic moral hazard with symmetric ex ante uncertainty about the difficulty of the job. The principal and agent update their beliefs about the difficulty as they observe output. Effort is private and the principal can only offer spot contracts. The agent has an additional incentive to shirk beyond the disutility of effort when the principal induces effort: shirking results in the principal having incorrect beliefs. 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

  • Venkataraman Bhaskar & George Mailath, 2016. "The Curse of Long Horizons," PIER Working Paper Archive 16-013, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 24 Jul 2016.
    • Handle: RePEc:pen:papers:16-013
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    References listed on IDEAS

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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. 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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