Optimality and Renegotiation in Dynamic Contracting

44 Pages Posted: 24 Aug 2005

See all articles by Marco Battaglini

Marco Battaglini

Princeton University - Department of Economics; Centre for Economic Policy Research (CEPR)

Date Written: April 2005

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, renegotiation, regulation

JEL Classification: D42, L51

Suggested Citation

Battaglini, Marco, Optimality and Renegotiation in Dynamic Contracting (April 2005). CEPR Discussion Paper No. 5014, Available at SSRN: https://ssrn.com/abstract=772751

Marco Battaglini (Contact Author)

Princeton University - Department of Economics ( email )

213 Fisher Hall
Princeton, NJ 08544
United States
609-258-4002 (Phone)
609-258-6419 (Fax)

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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