58 Pages Posted: 22 Jan 2015
Date Written: May 25, 2018
In an ongoing relationship of delegated decision making, a principal consults a biased agent to assess projects' returns. In equilibrium, the principal allows future bad projects to reward fiscal restraint, but cannot commit to indefinite rewards. We characterize equilibrium payoffs (at fixed discounting), showing that Pareto optimal equilibria are implemented via a two-regime 'Dynamic Capital Budget'. Rather than facing backloaded rewards—as in dynamic agency models with commitment power—the agent loses autonomy as time progresses. This transition toward conservatism echoes the life cycle of an organization: as it matures, it generates lower revenue at a higher yield.
Keywords: delegation, limited commitment, repeated game, capital budgeting
JEL Classification: C73, D23, D82, D86, G31
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