A Theory of Threshold Contracts

CER-ETH Working paper 13/182

66 Pages Posted: 16 Oct 2013

See all articles by Johannes Gerd Becker

Johannes Gerd Becker

CER-ETH - Center of Economic Research at ETH Zurich

Hans Gersbach

ETH Zurich - CER-ETH -Center of Economic Reseaarch; IZA Institute of Labor Economics; CESifo (Center for Economic Studies and Ifo Institute); Centre for Economic Policy Research (CEPR)

Date Written: October 14, 2013

Abstract

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

Becker, Johannes Gerd and Gersbach, Hans, A Theory of Threshold Contracts (October 14, 2013). CER-ETH Working paper 13/182. Available at SSRN: https://ssrn.com/abstract=2339958 or http://dx.doi.org/10.2139/ssrn.2339958

Johannes Gerd Becker (Contact Author)

CER-ETH - Center of Economic Research at ETH Zurich ( email )

Zürichbergstrasse 18
Zurich, 8092
Switzerland
+41446328272 (Phone)
+41446321830 (Fax)

HOME PAGE: http://www.cer.ethz.ch/mip

Hans Gersbach

ETH Zurich - CER-ETH -Center of Economic Reseaarch ( email )

Zürichbergstrasse 18
Zurich, 8092
Switzerland
+41 44 632 82 80 (Phone)
+41 44 632 18 30 (Fax)

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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