Working Paper: CEPR ID: DP14722
Authors: Daniel Garrett; Francesc Dilm
Abstract: We study relational contracting with an agent who has consumption-smoothing preferences as well as the ability to save to defer consumption (or to borrow). Our focus is the comparison of principal-optimal relational contracts in two settings. The first where the agent’s consumption and savings decisions are private, and the second where these decisions are publicly observed. In the first case, the agent smooths his consumption over time, the agent’s effort and payments eventually decrease with time, and the balances on his savings account eventually increase. In the second, the agent consumes earlier than he would like, consumption and the balance on savings fall over time, and effort and payments to the agent increase. Our results suggest a possible explanation for low savings rates in certain industries where compensation often comes in the form of discretionary payments.
Keywords: relational contracts; private savings
JEL Codes: C73; J30
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Consumption observability (D10) | Agent behavior (L85) |
| Consumption observability (D10) | Principal profits (D33) |
| Unobservable consumption (E21) | Consumption smoothing (D15) |
| Consumption smoothing (D15) | Decrease in effort and payments (G51) |
| Decrease in effort and payments (G51) | Decline in principal's profits (G19) |
| Observable consumption (D10) | Early consumption (D15) |
| Early consumption (D15) | Decrease in savings balance (D14) |
| Observable consumption (D10) | Increase in effort and payments (J33) |
| Increase in effort and payments (J33) | Increase in principal's profits (G19) |
| Agent's initial wealth (G19) | Principal profits (D33) |