The Curse of Long Horizons

48 Pages Posted: 4 Dec 2018

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: December 3, 2018

Abstract

We study dynamic moral hazard when the principal can only commit to spot contracts. Principal and agent are ex ante symmetrically uncertain about the difficulty of the job, and update their beliefs on observing output. Since the agent’s effort is private, he has an additional incentive to shirk when the principal induces effort: shirking results in the principal having incorrect beliefs, giving rise to future informational rents. 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, Venkataraman and Mailath, George J., The Curse of Long Horizons (December 3, 2018). PIER Working Paper No. 18-029, Available at SSRN: https://ssrn.com/abstract=3295838 or http://dx.doi.org/10.2139/ssrn.3295838

Venkataraman Bhaskar

University of Texas at Austin ( email )

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George J. Mailath (Contact Author)

University of Pennsylvania - Department of Economics ( email )

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