Discussion Paper Details

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Title: The curse of long horizons

Author(s): Venkataraman Bhaskar and George J Mailath

Publication Date: August 2016

Keyword(s): differences in beliefs, high-powered incentives, moral hazard and principal-agency

Programme Area(s): Industrial Organization

Abstract: We study dynamic moral hazard with symmetric ex ante uncertainty about the difficulty of the job. The principal and agent update their beliefs about the difficulty as they observe output. Effort is private and the principal can only offer spot contracts. The agent has an additional incentive to shirk beyond the disutility of effort when the principal induces effort: shirking results in the principal having incorrect beliefs. 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.

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Bibliographic Reference

Bhaskar, V and Mailath, G. 2016. 'The curse of long horizons'. London, Centre for Economic Policy Research.