Relational Incentive Contracts with Hidden Action and Unequal Discounting

Abstract

We analyze relational incentive contracts with hidden action when the principal and the agent have different discount factors, and identify a new agency cost that exists only when they cannot commit themselves to long-term contracts and the agent is more patient than the principal. We show that there is a new trade-off between rent extraction and incentive provision, and the optimal contract may be non-stationary, even without private information or limited-liability constraints. We characterize the condition under which the trade-off exists, as well as the condition for the optimality of non-stationary contracts.