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Optimal Contracts for Long‐Term Decisions and the Threat of Dismissal
Author(s) -
Kwon Illoong
Publication year - 2006
Publication title -
journal of economics and management strategy
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.672
H-Index - 68
eISSN - 1530-9134
pISSN - 1058-6407
DOI - 10.1111/j.1530-9134.2006.00116.x
Subject(s) - dismissal , discretion , principal (computer security) , incentive , wage , agency (philosophy) , principal–agent problem , term (time) , microeconomics , economics , moral hazard , labour economics , computer science , computer security , finance , law , political science , corporate governance , philosophy , physics , epistemology , quantum mechanics
This paper studies a simple agency model where an agent's decision can affect his or her own future payoffs as well as the principal's. The threat of dismissal becomes an important part of an incentive scheme even if the principal can use the performance‐based wage contract. However, if the agent's future payoffs depend on the past realized performance, but not on the past decision directly, or if the agent is risk‐neutral, it is not optimal to use the threat of dismissal. As the agent's discretion over his future payoffs increases, the principal relies more on the threat of dismissal but less on the wage contract.