Only the Final Outcome Matters: Persistent Effects of Efforts in Dynamic Moral Hazard

Abstract:     
We analyze a dynamic principal-agent problem in which the agent's effort in each period has strong persistent effects. We show that a simple contract, where the reward depends only on the final outcome, is explained as the optimal contract derived in the principal's optimization problem. The paper also discusses that the optimality of such a simple payment scheme crucially depends on the first-order stochastic dominance of the final outcome under various effort sequences.

Number of Pages in PDF File: 25

Keywords: dynamic moral hazard, history dependence, simple contract; first-order stochastic dominance

JEL Classification: C61, D82, D86

working papers series