Optimal equilibrium contracts in the infinite horizon with no commitment across periods

Subir K. Chakrabarti () and Jaesoo Kim ()
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Subir K. Chakrabarti: Indiana University Purdue University Indianapolis (IUPUI)
Jaesoo Kim: Indiana University Purdue University Indianapolis (IUPUI)

Theory and Decision, 2023, vol. 94, issue 3, No 2, 379-404

Abstract: Abstract The paper studies equilibrium contracts under adverse selection when there is repeated interaction between a principal and an agent over an infinite horizon, without commitment across periods. We show the second-best contract is offered in a perfect Bayesian equilibrium of the infinite horizon model. Unlike the equilibrium contracts in the finite-horizon, the equilibrium contracts in the infinite horizon are not subject to either the ratchet effect or take-the-money-and-run strategy, but rely on a carrot and stick strategy. We study two important applications, one of which is about the optimal regulation of a publicly-held firm. This application has a mixture of both moral hazard and adverse selection. The other application is to the problem of optimal nonlinear pricing when the valuation of the buyers are drawn from a continuum.

Keywords: Adverse selection; Games with incomplete information; Optimal contracts with commitment; Pooling contracts; Separating contracts; Perfect Bayesian equilibrium; Optimal contracts with no commitment (search for similar items in EconPapers)
Date: 2023
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DOI: 10.1007/s11238-022-09894-9

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