A Theory of Threshold Contracts
CER-ETH Working paper 13/182
66 Pages Posted: 16 Oct 2013
Date Written: October 14, 2013
We consider an infinitely repeated reappointment game in a principal-agent relationship. Typical examples are voter-politician or government-public servant relationships. The agent chooses costly effort and enjoys being in office until he is deselected. The principal observes a noisy signal of the agent's effort and decides whether to reappoint the agent or not. We analyse the stationary Markovian equilibria of this game and examine the consequences of threshold contracts, which forbid reappointment if the principal's utility is too low. We identify the circumstances under which such threshold contracts are welfare-improving or beneficial for the principal.
Keywords: principal-agent model; repeated game; reappointment; stationary Markovian strategies; threshold strategies; threshold contracts; asymmetric information; commitment
JEL Classification: C83, D82, D86, H11
Suggested Citation: Suggested Citation