University of Vienna
Institutional Affiliations: University of Vienna and CEPR and IZA
NBER Working Papers and Publications
|December 2010||Dynamic Incentive Contracts Under Parameter Uncertainty|
with Boyan Jovanovic: w16649
We analyze a long-term contracting problem involving common uncertainty about a parameter capturing the productivity of the relationship, and featuring a hidden action for the agent. We develop an approach that works for any utility function when the parameter and noise are normally distributed and when the effort and noise affect output additively. We then analytically solve for the optimal contract when the agent has exponential utility. We find that the Pareto frontier shifts out as information about the agent's quality improves. In the standard spot-market setup, by contrast, when the parameter measures the agent's 'quality', the Pareto frontier shifts inwards with better information.
Commitment is therefore more valuable when quality is known more precisely. Incentives then are eas...
Published: Jovanovic, Boyan & Prat, Julien, 2014. "Dynamic contracts when agent's quality is unknown," Theoretical Economics, Econometric Society, vol. 9(3), September. citation courtesy of