Contracting with a Present-Biased Agent: Sannikov meets Laibson

29 Pages Posted: 17 Jan 2022 Last revised: 2 Jun 2023

See all articles by Alejandro Rivera

Alejandro Rivera

University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics

Date Written: January 15, 2022

Abstract

This paper develops a methodology to solve dynamic principal-agent problems in which the agent features present-biased time preferences and naive beliefs. There are three insights. First, the problem has a recursive representation using the agent's perceived continuation value as a state variable (i.e., the remaining value the agent (wrongly) anticipates getting from the contract). Second, incentive compatibility corresponds to a volatility constraint on the agent's perceived continuation value. Finally, due to the agent's naivete, a perceived action constraint needs to be satisfied. This constraint is accommodated by linking the agent's perceived effort policy and the volatility of his perceived continuation value. Novel economic insights regarding optimal time-varying incentives and the term-structure of compensation are also explored.

Keywords: Dynamic Contracting, Behavioral Contracts, Present-Bias.

JEL Classification: D86, G40, C61.

Suggested Citation

Rivera, Alejandro, Contracting with a Present-Biased Agent: Sannikov meets Laibson (January 15, 2022). Available at SSRN: https://ssrn.com/abstract=4009513 or http://dx.doi.org/10.2139/ssrn.4009513

Alejandro Rivera (Contact Author)

University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics ( email )

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P.O. Box 830688
Richardson, TX 75083
United States

HOME PAGE: http://jindal.utdallas.edu/faculty/alejandro-rivera

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