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Dynamic agency with persistent observable shocks

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  • Li, Rui

Abstract

This paper studies a continuous-time hidden-action model with persistent observable shocks. In this model, I develop a method to characterize the optimal contract with history-dependent effort exertion and shirking decisions. Temporal shirking is always optimal after some histories as long as a positive persistent shock is expected. As a result, my model gives rise to a mechanism through which the moral hazard problem amplifies macroeconomic fluctuations. I also show the pattern of the agent’s utility adjustments with respect to persistent shocks and its implications for compensation design.

Suggested Citation

  • Li, Rui, 2017. "Dynamic agency with persistent observable shocks," Journal of Mathematical Economics, Elsevier, vol. 71(C), pages 74-91.
    • Handle: RePEc:eee:mateco:v:71:y:2017:i:c:p:74-91
    DOI: 10.1016/j.jmateco.2017.04.003
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    References listed on IDEAS

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    Cited by:

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    2. Borys Grochulski & Russell Wong & Yuzhe Zhang, 2017. "Optimal Incentive Contracts with Job Destruction Risk," Working Paper 17-11, Federal Reserve Bank of Richmond.

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