NDLI: Dynamic incentive contracts with termination threats

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Dynamic incentive contracts with termination threats

Content Provider	Springer Nature Link
Author	Olcay, Nadide Banu
Copyright Year	2016
Abstract	We consider a dynamic moral hazard model where the principal offers a series of short-run contracts. We study the optimal mix of two alternative instruments for incentive provision: a performance based wage (a “carrot”) and a termination threat (a “stick”). At any given point in time, these instruments are substitutes in the provision of incentives. We are particularly interested in the dynamic interaction of these two instruments. Both carrot and stick are used more intensively as the agent approaches the end of his finite life. The sharing of the surplus of the relationship plays a key role: a termination threat is included in the optimal contract if and only if the agent’s expected future gain from the relationship is sufficiently high, compared to the principal’s expected future gain. Also, a termination threat is more likely to be optimal if output depends more on “luck” than on effort, if the discount factor is high, or if the agent’s productivity is low. The model, provided that the optimal contract includes a termination threat, essentially provides an alternative explanation for upward-sloping wage profiles even in the absence of full-commitment.
Starting Page	255
Ending Page	288
Page Count	34
File Format	PDF
ISSN	14344742
Journal	Review of Economic Design
Volume Number	20
Issue Number	4
e-ISSN	14344750
Language	English
Publisher	Springer Berlin Heidelberg
Publisher Date	2016-08-30
Publisher Place	Berlin, Heidelberg
Access Restriction	One Nation One Subscription (ONOS)
Subject Keyword	Principal-agent Dynamic contracts Moral hazard Incentives Economics Economic Theory/Quantitative Economics/Mathematical Methods Game Theory, Economics, Social and Behav. Sciences Microeconomics Behavioral/Experimental Economics
Content Type	Text
Resource Type	Article
Subject	Economics, Econometrics and Finance

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