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 languageEnglish
Pages (from-to)551-594
Number of pages44
JournalJournal of Economic Theory
Volume178
DOIs
StatePublished - Nov 2018

Bibliographical note

Funding Information:
This paper previously circulated under the title “Intertemporal Incentives With Expectation-Based Reference-Dependent Preferences” and is based in one of my dissertation chapters at UC Berkeley. I am thus indebted to my advisors Botond Kőszegi and Matthew Rabin for their guidance and support. I am also grateful to Ben Hermalin, Paul Heidhues and Joaquín Poblete for useful discussions. I thank further Pedro Gardete, Iván Kőszegi (mindenekelőtt), Maciej Kotowski, Casey Rothschild, Josh Tasoff and Mike Urbancic for useful comments, and seminar participants at University of Alicante, Middlebury College, Pompeu Fabra, University of Warwick, Universidad de Chile, and Pontificia Universidad Católica de Chile, among others. This work was supported by Conicyt FONDECYT Grant Iniciación #11140101.

Publisher Copyright:
© 2018 Elsevier Inc.

Keywords

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

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