Working Paper: CEPR ID: DP5014
Authors: Marco Battaglini
Abstract: We characterize the optimal renegotiation-proof contract in a dynamic Principal-Agent model in which the type of the agent may change stochastically over time. Contrary to the case with constant types, the ex ante optimal contract may be renegotiation-proof even if types are highly correlated. The marginal benefit of having some pooling of types in the first period is not monotonic in their persistence level, but the equilibrium level of pooling is non-decreasing in persistence; and, for any level persistence, it is always optimal to partially screen the types by offering a menu of choices to the agent. Despite the non-linearity of the problem, the optimal equilibrium allocation is unique.
Keywords: contract theory; dynamic contracts; regulation; renegotiation
JEL Codes: D42; L51
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| optimal contract (D86) | renegotiation-proofness (C78) |
| persistence of types (C41) | optimal renegotiation-proof contract (D86) |
| correlation of agent types (C10) | relationship between optimality and renegotiation-proofness (C78) |
| equilibrium level of pooling (C62) | persistence of types (C41) |
| marginal benefit of pooling types (C46) | persistence (C41) |
| optimal renegotiation-proof contract (D86) | persistence of type realizations (L15) |