Dynamic Contracts Under Loss Aversion

Sofia Moroni

No 5868, Working Paper from Department of Economics, University of Pittsburgh

Abstract: We analyze a dynamic moral hazard principal-agent model with an agent who is lossaverse and whose reference updates according to the previous period’s consumption.When there is full commitment and the agent has no access to credit, in every periodafter the first the optimal payment scheme is insensitive to the current outcome in an interval,offering to pay the reference for a set of performance measures. Therefore, thereis a positive probability of observing wage persistence even if outcomes vary over time.Moreover, the model predicts a “status quo bias†–a preference for consuming the fullallocation if the agent is allowed to intertemporally reallocate consumption after the outcomeis realized. This result in turn implies that unlike the canonical model, the optimalcontract may be implemented even when the agent has access to a savings technology.We use subdifferential calculus to address the non-differentiable utility function.

Date: 2016-01
New Economics Papers: this item is included in nep-mic and nep-upt
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Related works:
Working Paper: Dynamic Contracts Under Loss Aversion (2015)
Working Paper: Dynamic Contracts Under Loss Aversion (2012)
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