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The Curse of Long Horizons

Author

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  • V. Bhaskar

    (Department of Economics, University of Texas at Austin)

  • George J. Mailath

    (Department of Economics, University of Pennsylvania)

Abstract

We study dynamic moral hazard when the principal can only commit to spot contracts. Principal and agent are ex ante symmetrically uncertain about the difficulty of the job, and update their beliefs on observing output. Since the agent’s effort is private, he has an additional incentive to shirk when the principal induces effort: shirking results in the principal having incorrect beliefs, giving rise to future informational rents. 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

  • V. Bhaskar & George J. Mailath, 2016. "The Curse of Long Horizons," PIER Working Paper Archive 18-029, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania, revised 03 Dec 2018.
  • Handle: RePEc:pen:papers:18-029
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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. Gao, Hong & Xu, Haibo, 2020. "Learning, belief manipulation and optimal relationship termination," Economics Letters, Elsevier, vol. 190(C).
    3. 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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