Implications of Unequal Discounting in Dynamic Contracting

47 Pages Posted: 19 Mar 2018 Last revised: 12 Nov 2020

See all articles by Ilia Krasikov

Ilia Krasikov

Pennsylvania State University

Rohit Lamba

Pennsylvania State University - College of the Liberal Arts

Thomas Mettral

Humboldt University of Berlin

Date Written: November 12, 2020

Abstract

A principal and agent sign on a dynamic contract where (i) the agent has Markovian private information that affects total surplus, (ii) the principal can commit to the contract and the agent has limited commitment, and (iii) the principal is more patient than the agent. The interaction of these three forces, which captures many applications in financial contracting, produces permanent distortions that go through cycles. The standard rent-versus-efficiency tradeoff that determines the optimal distortion is now enriched by two competing dynamic considerations: The principal backloads agent’s information rent as much as possible to relax incentive constraints, but unequal discounting introduces inter-temporal costs of incentive provision which front-load agent’s payoffs. The optimal contract pins down this tradeoff. Persistence of private information creates technical challenges in determining the set of binding incentive constraints– to deal with it, a notion of simplicity and approximate optimality is introduced.

Keywords: Dynamic Mechanism Design, Financial Contracting, Unequal Discounting

JEL Classification: D82, D86

Suggested Citation

Krasikov, Ilia and Lamba, Rohit and Mettral, Thomas, Implications of Unequal Discounting in Dynamic Contracting (November 12, 2020). Available at SSRN: https://ssrn.com/abstract=3142932 or http://dx.doi.org/10.2139/ssrn.3142932

Ilia Krasikov

Pennsylvania State University ( email )

University Park
State College, PA 16802
United States

Rohit Lamba (Contact Author)

Pennsylvania State University - College of the Liberal Arts ( email )

University Park, PA 16802-3306
United States

HOME PAGE: http://www.rohitlamba.com

Thomas Mettral

Humboldt University of Berlin ( email )

Unter den Linden 6
Berlin, AK Berlin 10099
Germany

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