The Curse of Long Horizons

40 Pages Posted: 1 Sep 2016

See all articles by V. Bhaskar

V. Bhaskar

University College London

George J. Mailath

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

Date Written: July 24, 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: principal-agency, moral hazard, differences in beliefs, high-powered incentives

JEL Classification: D01, D23, D86, J30

Suggested Citation

Bhaskar, V. and Mailath, George J., The Curse of Long Horizons (July 24, 2016). PIER Working Paper No. 16-013, Available at SSRN: https://ssrn.com/abstract=2831557 or http://dx.doi.org/10.2139/ssrn.2831557

V. Bhaskar

University College London ( email )

Gower Street
London
United Kingdom

George J. Mailath (Contact Author)

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
133 South 36th Street
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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