Optimal Contract for Long-Term Decisions and Threat of Dismissal
Journal of Economics & Management Strategy, Vol. 15, No. 3, 2006
Posted: 1 Feb 2010
Date Written: 2006
This paper studies a simple agency model where an agent's decision can affect his or her own future payoffs as well as the principal's. The threat of dismissal becomes an important part of an incentive scheme even if the principal can use the performance-based wage contract. However, if the agent's future payoffs depend on the past realized performance, but not on the past decision directly, or if the agent is risk-neutral, it is not optimal to use the threat of dismissal. As the agent's discretion over his future payoffs increases, the principal relies more on the threat of dismissal but less on the wage contract.
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