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Optimal Self-enforcing and Termination

  • Cheng Wang

    (Iowa State University)

We study a dynamic principal-agent relationship in which the agent receives a stochastic outside opportunity/offer each period and he cannot commit to not leaving the ongoing relationship.Termination, while costly, allows the principal to go to an external market to hire a new agent. We treat self-enforcing as a choice variable by letting the principal respond strategically to the agent's outside offers. Starting initially from a sufficiently low expected utility of the agent (so the commitment constraint is binding, initially), the continuation of the optimal contract converges to Burdett (1978) where each period the agent quits whenever his outside offer is above the utility the current principal offers, and he stays to receive the same constant expected utility otherwise. On the path of convergence, termination occurs whenever the agent's outside offer exceeds a constant ceiling, and the principal acts to match the agent's outside offer if it is below that constant ceiling but better than his current promised utility. The convergence is monotonic. Conditional on continuation, over time the agent's expected utility converges monotonically to its limiting level while the commitment constraint binds monotonically less; and the limiting utility of the agent is the lowest level of his expected utility at which the commitment constraint is not binding.

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Paper provided by Society for Economic Dynamics in its series 2012 Meeting Papers with number 433.

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Date of creation: 2012
Date of revision:
Handle: RePEc:red:sed012:433
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

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  1. Mortensen, Dale & Pissarides, Christopher, 2011. "Job Creation and Job Destruction in the Theory of Unemployment," Economic Policy, Russian Presidential Academy of National Economy and Public Administration, vol. 1, pages 19 pages.
  2. Wang, Cheng, 2005. "Termination of Dynamic Contracts in an Equilibrium Labor Market Model," Staff General Research Papers Archive 12403, Iowa State University, Department of Economics.
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  4. Narayana Kocherlakota, 2010. "Implications of Efficient Risk Sharing Without Commitment," Levine's Working Paper Archive 2053, David K. Levine.
  5. Spear, Stephen E. & Wang, Cheng, 2005. "When to Fire a CEO: Optimal Termination in Dynamic Contracts," Staff General Research Papers Archive 11443, Iowa State University, Department of Economics.
  6. Yuliy Sannikov, 2008. "A Continuous-Time Version of the Principal-Agent Problem," Review of Economic Studies, Oxford University Press, vol. 75(3), pages 957-984.
  7. Peter M. DeMarzo & Michael J. Fishman, 2007. "Optimal Long-Term Financial Contracting," Review of Financial Studies, Society for Financial Studies, vol. 20(6), pages 2079-2128, November.
  8. Jovanovic, Boyan, 1984. "Matching, Turnover, and Unemployment," Journal of Political Economy, University of Chicago Press, vol. 92(1), pages 108-22, February.
  9. Giuseppe Moscarini, 2005. "Job Matching and the Wage Distribution," Econometrica, Econometric Society, vol. 73(2), pages 481-516, 03.
  10. Cheng Wang, 2010. "Dynamic Insurance with Private Information and Balanced Budgets," Levine's Working Paper Archive 2064, David K. Levine.
  11. Stephen E. Spear & Sanjay Srivastava, 1987. "On Repeated Moral Hazard with Discounting," Review of Economic Studies, Oxford University Press, vol. 54(4), pages 599-617.
  12. Debraj Ray, 2002. "The Time Structure of Self-Enforcing Agreements," Econometrica, Econometric Society, vol. 70(2), pages 547-582, March.
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