Working Paper: CEPR ID: DP13227
Authors: Florian Englmaier; Matthias Fahn; Marco Schwarz
Abstract: We analyze how agents' present bias affects optimal contracting in an infinite-horizon employment setting. The principal maximizes profits by offering a menu of contracts to naive agents: a "virtual" contract - which agents plan to choose in the future - and a "real" contract which they end up choosing. This virtual contract motivates the agent and allows the principal to keep the agent below his outside option. Moreover, under limited liability, implemented effort can be inefficiently high. With a finite time horizon, the degree of exploitation of agents decreases over the life-cycle. While the baseline model abstracts from moral hazard, we show that the result persists also when allowing for non-contractible effort.
Keywords: Employment relations; Dynamic contracting; Present bias
JEL Codes: D03; D21; J31; M52
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| present bias (D15) | exploitation of agents through contract design (D86) |
| present bias (D15) | choice of real contract leading to lower utility than outside option (D86) |
| virtual contract designed to be unattractive (L14) | defer acceptance (Y60) |
| exploitation of agents' misperceptions about future choices (D82) | systematic underperformance in utility (L94) |
| age (J14) | decrease in exploitation over lifecycle (D25) |
| changes in employment protection legislation (J63) | harm to naive agents (D82) |
| optimal contract structure (D86) | higher effort levels than socially optimal (D29) |