Of Restarts and Shutdowns: Dynamic Contracts with Unequal Discounting

Ilia Krasikov, Rohit Lamba and Thomas Mettral
Additional contact information
Ilia Krasikov: Penn State University;
Rohit Lamba: Penn State University
Thomas Mettral: HU Berlin

No 94, Rationality and Competition Discussion Paper Series from CRC TRR 190 Rationality and Competition

Abstract: A large supplier (principal) contracts with a small firm (agent) to repeatedly provide working capital in return for payments. The total factor productivity of the agent is private and follows a Markov process. Moreover, the agent is less patient than the principal. We solve for the optimal contract in this environment. Distortions are pervasive and efficiency unattainable. The optimal contract is characterized by two key properties: restart and shutdown, which capture various aspects of contracts offered in the marketplace. The optimal distortions are completely pinned down by the number of low TFP shocks since the last high shock. Once a high shock arrives, the contract loses memory and repeats the same cycle, we call this endogenous resetting feature restart. If ex ante agency frictions are high, the principal commits to not serving the low type, we call this shutdown. The principal prefers a patient agent if the interim agency friction, as measured by the persistence of the private information is large, and she prefers an impatient agent if it is small. Finally, when global incentive constraints bind, we (i) provide the complete recursive solution, and (ii) characterize a simpler incentive compatible contract that is approximately optimal.

Date: 2018-04-24
New Economics Papers: this item is included in nep-cta, nep-hrm and nep-mic
References: Add references at CitEc
Citations:

Downloads: (external link)
https://rationality-and-competition.de/wp-content/ ... cussion_paper/94.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:rco:dpaper:94

Access Statistics for this paper

More papers in Rationality and Competition Discussion Paper Series from CRC TRR 190 Rationality and Competition
Bibliographic data for series maintained by Viviana Lalli ().