The Effects and the Design of Incentives in Dynamic, Non-Repeated Principal-Agent Models
Final Report Abstract
The research supported by DFG examines the effect and design of incentives in a dynamic principal-agent model for project completion. The novel aspect of this research is to consider economic interaction that is modelled as a dynamic but non-repeated game since payoffs that the interacting parties receive upon project completion vary over time. For this purpose, a suitable model framework was first developed to reflect this dynamic, non-repeated principal-agent relationship. This model was then used to analyze the conditions under which stronger financial incentives negatively affect (i) agents’ efforts and (ii) the probability of project success. Moreover, it was also shown that a project with stronger incentives is not necessarily more attractive for the agents. By considering a principal who optimally designs intertemporal incentives, we also reveal that a more lucrative project can lead to a design of incentives that makes both contracting parties worse off and project success less likely. It was shown that these interesting effects may occur with different incentive mechanisms: Both with short-term “spot contracts” and with “long-term contracts” (given that the principal cannot exclude renegotiating future incentives). In both cases, the principal cannot adequately account for the negative intertemporal consequences of higher incentives on agents’ efforts in other periods when designing the contract. Overall, the analysis provides numerous new and relevant insights, which are relevant from a theoretical and practical perspective. The model can, for example, provide an explanation based on contract theory as to why delays and failures often occur frequently in the implementation of projects, even if high-powered incentives are provided.
