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Moral Hazard and Persistence

Hugo Hopenhayn and Arantxa Jarque

No 670, 2006 Meeting Papers from Society for Economic Dynamics

Abstract: We study a multiperiod principal-agent problem with moral hazard in which the agent is required to exert effort only in the initial period of the contract. The effort choice of the agent in this first period determines the conditional distribution of output in the following periods. The paper characterizes the optimal compensation scheme. We find that the results for the static moral hazard problem extend to this setting: consumption at each point in time is ranked according to the likelihood ratio of the corresponding history. As the length of the contract increases, the cost of implementing effort decreases, and consumption on the equilibrium path becomes less volatile. If the contract lasts for an infinite number of periods, assuming the effect of effort does not depreciate with time, the cost of the principal gets arbitrarily close to that of the first best

Keywords: mechanism design; moral hazard; persistence; dynamic contracts (search for similar items in EconPapers)
JEL-codes: D31 D80 D82 (search for similar items in EconPapers)
Date: 2006-12-03
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