A Theory of Threshold Contracts

68 Pages Posted: 17 Jan 2017

See all articles by Johannes Gerd Becker

Johannes Gerd Becker

ZHAW School of Management and Law

Hans Gersbach

ETH Zurich - CER-ETH -Center of Economic Research; IZA Institute of Labor Economics; CESifo (Center for Economic Studies and Ifo Institute); Centre for Economic Policy Research (CEPR)

Date Written: January 2017

Abstract

We consider an infinitely repeated reappointment game in a principal-agent relationship and examine the consequences of threshold contracts, which forbid reappointment if the principal's utility is too low. Typical examples are voter-politician or government-public servant relationships. The agent chooses costly effort and enjoys being in office until he is deselected. The principal observes a noisy signal of the agent's effort and decides whether to reappoint the agent or not. We analyse the stationary Markovian equilibria of this game with and without threshold contracts. We identify the circumstances under which such threshold contracts are welfare-improving or beneficial for the principal, which, in turn, may justify attempts to introduce such contracts in politics.

Keywords: asymmetric information, commitment., principal-agent model, reappointment, repeated game, stationary Markovian strategies, threshold contracts, threshold strategies

JEL Classification: C83, D82, D86, H11

Suggested Citation

Becker, Johannes Gerd and Gersbach, Hans, A Theory of Threshold Contracts (January 2017). CEPR Discussion Paper No. DP11766, Available at SSRN: https://ssrn.com/abstract=2900183

Johannes Gerd Becker (Contact Author)

ZHAW School of Management and Law ( email )

St.-Georgen-Platz 2
Winterthur, 8401
Switzerland

Hans Gersbach

ETH Zurich - CER-ETH -Center of Economic Research ( email )

Zürichbergstrasse 18
Zurich, 8092
Switzerland
+41 44 632 82 80 (Phone)
+41 44 632 18 30 (Fax)

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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