The Curse of Long Horizons

42 Pages Posted: 16 Aug 2016

See all articles by Venkataraman Bhaskar

Venkataraman Bhaskar

University of Texas at Austin

George J. Mailath

University of Pennsylvania - Department of Economics; Research School of Economics, ANU

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Date Written: August 2016

Abstract

We study dynamic moral hazard with symmetric ex ante uncertainty about the difficulty of the job. The principal and agent update their beliefs about the difficulty as they observe output. Effort is private and the principal can only offer spot contracts. The agent has an additional incentive to shirk beyond the disutility of effort when the principal induces effort: shirking results in the principal having incorrect beliefs. We show that the effort inducing contract must provide increasingly high powered incentives as the length of the relationship increases. Thus it is never optimal to always induce effort in very long relationships.

Keywords: differences in beliefs, high-powered incentives., moral hazard, principal-agency

JEL Classification: D01, D23, D86, J30

Suggested Citation

Bhaskar, Venkataraman and Mailath, George J., The Curse of Long Horizons (August 2016). CEPR Discussion Paper No. DP11431, Available at SSRN: https://ssrn.com/abstract=2823456

Venkataraman Bhaskar (Contact Author)

University of Texas at Austin ( email )

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Austin, TX 78712
United States

George J. Mailath

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
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Philadelphia, PA 19104-6297
United States
215-898-7908 (Phone)
215-573-2057 (Fax)

HOME PAGE: http://web.sas.upenn.edu/gmailath/

Research School of Economics, ANU ( email )

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College of Business and Economics
Canberra, ACT 2601
Australia

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