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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
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Handle: RePEc:red:sed012:433
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  1. Stephen Spear & Cheng Wang, . "When to Fire a CEO: Optimal Termination in Dynamic Contracts," GSIA Working Papers 2002-E5, Carnegie Mellon University, Tepper School of Business.
  2. Wang, Cheng, 1995. "Dynamic Insurance with Private Information and Balanced Budgets," Review of Economic Studies, Wiley Blackwell, vol. 62(4), pages 577-95, October.
  3. Thomas, Jonathan & Worrall, Tim, 1988. "Self-enforcing Wage Contracts," Review of Economic Studies, Wiley Blackwell, vol. 55(4), pages 541-54, October.
  4. 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.
  5. Debraj Ray, 2002. "The Time Structure of Self-Enforcing Agreements," Econometrica, Econometric Society, vol. 70(2), pages 547-582, March.
  6. Kocherlakota, Narayana R, 1996. "Implications of Efficient Risk Sharing without Commitment," Review of Economic Studies, Wiley Blackwell, vol. 63(4), pages 595-609, October.
  7. Phelan Christopher, 1995. "Repeated Moral Hazard and One-Sided Commitment," Journal of Economic Theory, Elsevier, vol. 66(2), pages 488-506, August.
  8. Wang, Cheng, 2005. "Termination of Dynamic Contracts in an Equilibrium Labor Market Model," Staff General Research Papers 12403, Iowa State University, Department of Economics.
  9. Giuseppe Moscarini, 2005. "Job Matching and the Wage Distribution," Econometrica, Econometric Society, vol. 73(2), pages 481-516, 03.
  10. 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.
  11. Spear, Stephen E & Srivastava, Sanjay, 1987. "On Repeated Moral Hazard with Discounting," Review of Economic Studies, Wiley Blackwell, vol. 54(4), pages 599-617, October.
  12. Dale T. Mortensen & Christopher A. Pissarides, 1993. "Job Creation and Job Destruction in the Theory of Unemployment," CEP Discussion Papers dp0110, Centre for Economic Performance, LSE.
  13. Jovanovic, Boyan, 1984. "Matching, Turnover, and Unemployment," Journal of Political Economy, University of Chicago Press, vol. 92(1), pages 108-22, February.
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