Incentives and Performance with Optimal Money Management Contracts
Journal of Political Economy, forthcoming
49 Pages Posted: 21 Nov 2019 Last revised: 23 Feb 2023
Date Written: June 26, 2022
I characterize the dynamics of incentives in an optimal contract with investment delegation, moral hazard, and uncertainty about the agent's productivity. The principal increases the agent's incentives after good performance in order to delegate more capital to an agent with higher perceived productivity, thus implementing a convex pay-for-performance scheme. Moreover, the principal commits to reduce the agent's future incentives in order to mitigate ex-ante investment distortions. Methodologically, I provide a duality-based strategy to overcome technical challenges common to continuous-time contracting models with state variables. I also derive a sufficient condition to verify the validity of the first-order approach.
Keywords: Dynamic contracts, managerial compensation, duality, dynamic programming, delegated investment
JEL Classification: D86, D82, C73, C61, J33, M52
Suggested Citation: Suggested Citation