Intertemporal incentives under loss aversion

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Abstract

This paper studies the intertemporal allocation of incentives in a repeated moral hazard model where the loss averse agent experiences today utility from changes in their expectations about present and future wages and effort. In contrast to the standard prediction, under mild restrictions over the utility function, uncertainty is fully deferred into future payments allowing the principal to pay fixed wages. Although the intertemporal allocation of incentives is nonstandard, the optimal contract is well behaved as essential features of the contract with classical preferences—no rents to the agent, conditions to achieve first-best cost and non-optimality of ex-post random contracts—still hold.
Original languageAmerican English
Pages (from-to)551-594
Number of pages44
JournalJournal of Economic Theory
Volume178
DOIs
StatePublished - 1 Nov 2018

Keywords

  • Dynamic moral hazard
  • Expectation-based reference-dependent preferences
  • Loss aversion

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