Only the Final Outcome Matters: Persistent Effects of Efforts in Dynamic Moral Hazard

Abstract

We analyze a dynamic principal–agent problem in which the agent’s effort in each period has strong persisitent effects. We show that a simple contract, in the sense that the reward depends only on the final outcome, is explained as the optimal contract derived in the principal’s optimization problem. The paper also discusses that the optimality of such a simple payment scheme crucially depends on the first-order stochastic dominance of the final outcome under various effort sequences.