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Contracting with cost synergies: Continuous-time double-sided moral hazard

Author

Listed:
  • Yang, Nian
  • Yang, Jun
  • Chen, Yu

Abstract

We study optimal effort and compensation in two continuous-time double-sided models with cost synergies. In the co-work synergy model, cost synergies exist between two agents with ongoing effort: each agent's effort reduces his colleague's marginal cost of effort. The agents completely divide the project's cash flow. In the optimal contract, the agent with higher productivity and a bigger cost-reduction influence claims a larger fraction of the cash flow. In the chain synergy model, one agent exerts initial effort to start the project, and her colleague exerts ongoing effort to manage it. The upfront effort reduces the marginal cost of her colleague's ongoing effort. The timing of optimal payments reflects cost synergies across agents and the timing of efforts: Upfront effort corresponds to early payments. We show that the introduction of cost synergies not only alters the allocation of the cash flow but also improves the expected social surplus. This study suggests that cost synergies increase efficiency for a broad set of contracting problems involving teams.

Suggested Citation

  • Yang, Nian & Yang, Jun & Chen, Yu, 2024. "Contracting with cost synergies: Continuous-time double-sided moral hazard," Journal of Economic Dynamics and Control, Elsevier, vol. 168(C).
  • Handle: RePEc:eee:dyncon:v:168:y:2024:i:c:s0165188924001635
    DOI: 10.1016/j.jedc.2024.104971
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    More about this item

    Keywords

    Optimal contracting; Incentives; Cost synergies; Efficiency;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • J31 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Wage Level and Structure; Wage Differentials
    • M52 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics - - - Compensation and Compensation Methods and Their Effects

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