The Optimal Duration of Contracts

46 Pages Posted: 21 Feb 2018

See all articles by Panu Poutvaara

Panu Poutvaara

Ludwig Maximilian University of Munich (LMU) - Faculty of Economics; ifo Institut - Leibniz-Institut fuer Wirtschaftsforschung an der Universitaet Muenchen e.V.; CESifo (Center for Economic Studies and Ifo Institute); CReAM; IZA Institute of Labor Economics

Tuomas Takalo

Bank of Finland, Monetary Policy and Research Department; VATT Institute for Economic Research

Andreas Wagener

Leibniz Universität Hannover - Economics and Business Administration Area; CESifo (Center for Economic Studies and Ifo Institute for Economic Research); Vienna University of Economics and Business Administration

Date Written: January 15, 2018

Abstract

We study the optimal duration of contracts in a principal-agent framework with both moral hazard and adverse selection. Agents decide on a contract-specific and non-verifiable investment. Incentive compatibility requires that initial contracts, which serve to screen the ability of newly hired agents, cannot be longer than continuation contracts, offered to successful agents. Initial contracts remain unpaid unless service quality is unobservable to other agents and the share of high-ability agents is high. Optimal durations depend, in non-monotonic ways, on the principal’s ow valuation of the agent’s service and the share of high-ability agents.

Keywords: contract length, term length, screening

JEL Classification: J300, L140, J410, D720

Suggested Citation

Poutvaara, Panu and Takalo, Tuomas and Wagener, Andreas, The Optimal Duration of Contracts (January 15, 2018). CESifo Working Paper Series No. 6808, Available at SSRN: https://ssrn.com/abstract=3126012

Panu Poutvaara (Contact Author)

Ludwig Maximilian University of Munich (LMU) - Faculty of Economics ( email )

Ludwigstrasse 28
Munich, D-80539
Germany

HOME PAGE: http://www.iiv.vwl.uni-muenchen.de/index.html

ifo Institut - Leibniz-Institut fuer Wirtschaftsforschung an der Universitaet Muenchen e.V. ( email )

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HOME PAGE: http://https://www.ifo.de/poutvaara-p

CESifo (Center for Economic Studies and Ifo Institute) ( email )

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CReAM ( email )

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IZA Institute of Labor Economics ( email )

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Tuomas Takalo

Bank of Finland, Monetary Policy and Research Department ( email )

P.O. Box 160
Helsinki, FIN-00101
Finland

HOME PAGE: http://https://sites.google.com/site/tuomastakalo/

VATT Institute for Economic Research

Andreas Wagener

Leibniz Universität Hannover - Economics and Business Administration Area ( email )

Koenigsworther Platz 1
30167 Hannover
Germany

CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

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Munich, DE-81679
Germany

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Vienna University of Economics and Business Administration ( email )

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