Title

Optimal Dynamic Contracting

Author(s)

Marco Battaglini Marco Battaglini (Princeton University)

Rohit Lamba Rohit Lamba (Princeton University)

Abstract

We study a simple dynamic Principal-Agent model in which the agent?s types are serially correlated. In these models, the standard approach consists in first solving a relaxed version in which only local incentive compatibility constraints are considered, and then in proving that the local constraints are sufficient for implementability. We show that, with the exception of few notable examples highlighted in the literature, this approach is not generally valid: even assuming standard regularity conditions, both local and global incentive constraints are generally binding when serial correlation is sufficiently high. We uncover a number of interesting features of the optimal contract that cannot be observed in the special environments in which the standard approach works. Finally, we show that even in complex environments, approximately optimal allocations can be easily characterized by focusing on a particular class of contracts in which the allocation is forced to be monotonic.

Creation Date

2012-10

Section URL ID

ET

Paper Number

wp046_2012_Battaglini_Lamba_optm_dyn_contract_10october2012_short.pdf

URL

http://detc.princeton.edu/wp-content/uploads/2016/11/wp046_2012_Battaglini_Lamba_optm_dyn_contract_10october2012_short.pdf

File Function

Jel

C010, C020, C700, D010

Keyword(s)

models, optimal allocation, complex environment

Suppress

false

Series

10