John Y Zhu
Review of Economic Studies, 2018, vol. 85, issue 2, 1352-1388
I consider a dynamic principal-agent setting in which the agent repeatedly chooses between hidden long-term and short-term actions. Relative to the long-term action, the short-term action boosts output today but hurts output tomorrow. I explicitly characterize the optimal contract that always induces the long-term action. It features a cliff-like arrangement that rewards high output today based on the streak of consecutive high outputs the agent has generated leading up to today: The longer the streak, the larger the reward. The optimal contract can be implemented as a bonus bank. Bonus banks feature prominently in the recent debate on bonus reform. I shed light on the opposing arguments driving this debate by formally comparing the myopic agency optimal contract and optimal contracts that arise from traditional effort-shirking agency models.
Keywords: Principal-agent; Dynamic contract; Myopia; Robust contract; Investment; Bonus deferral; Bonus bank; Long-term; Short-term; Persistent moral hazard (search for similar items in EconPapers)
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Persistent link: https://EconPapers.repec.org/RePEc:oup:restud:v:85:y:2018:i:2:p:1352-1388.
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