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

Author

Listed:
  • Subir K. Chakrabarti

    (Indiana University Purdue University Indianapolis (IUPUI))

  • Jaesoo Kim

    (Indiana University Purdue University Indianapolis (IUPUI))

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.

Suggested Citation

  • Subir K. Chakrabarti & Jaesoo Kim, 2023. "Optimal equilibrium contracts in the infinite horizon with no commitment across periods," Theory and Decision, Springer, vol. 94(3), pages 379-404, April.
    • Handle: RePEc:kap:theord:v:94:y:2023:i:3:d:10.1007_s11238-022-09894-9
    DOI: 10.1007/s11238-022-09894-9
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    References listed on IDEAS

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