Essays in dynamic contracting

Abstract

This thesis examines three models of dynamic contracting. The first model is a model of dynamic moral hazard with partially persistent states, and the second model considers relational contracts when the states are partially persistent. The last model studies preference for delegation with learning. In the first chapter, the costly unobservable action of the agent produces a good outcome with some probability, and the probability of the good outcome corresponds to the state. The states are unobservable and follow an irreducible Markov chain with positive persistence. The chapter finds that an informational rent arises in this environment. The second best contract resembles a tenure system: the agent is paid nothing during the probationary period, and once he is paid, the principal never takes his outside option again. The second best contract becomes stationary after the agent is tenured. For discount factors close to one, the principal can approximate his first best payoff with review contracts. The second chapter studies relational contracts with partially persistent states, where the distribution of the state depends on the previous state. When the states are observable, the optimal contracts can be stationary, and the self-enforcement leads to the dynamic enforcement constraint as with i.i.d. states. The chapter then applies the results to study the implications for the markets where the principal and the agent can be matched with new partners. The third chapter studies preference for delegation when there is a possibility of learning before taking an action. The optimal action depends on the unobservable state. After the principal chooses the manager, one of the agents may receive a private signal about the world. The agent decides whether to disclose the signal to the manager, and the manager chooses an action. In an equilibrium, the agents' communication strategies depend on the manager's prior. The principal prefers a manager with some difference in prior belief to a manager with the same prior.