Essays on relational contracts and repeated games

Huanxing Yang, University of Pennsylvania

Abstract

This dissertation studies the role of market friction in overcoming moral hazard in market settings without information flows. It consists of four chapters. The first chapter introduces the general topic. The second chapter studies optimal wage contracts for motivating workers. It compares three ways of motivating workers: efficiency wages, objective performance pay, and subjective performance pay. The model predicts that an optimal wage contract is a function of job characteristics varying across different labor markets. Specifically, the amount of subjective performance pay is positively correlated, and the amount of efficiency wages is negatively correlated, with turnover costs. Surprisingly, a certain degree of market friction is beneficial for overcoming moral hazard. The predictions of the model are consistent with empirical evidence. The third chapter studies contract dynamics in labor market relationships. Workers are heterogeneous and each worker's ability is private information. Learning therefore occurs within employment relationships. The inferences, however, are confounded by moral hazard. Incentive provision is restricted by an inability to commit to long-term contracts. Relational contracts, which are self-enforcing, must therefore be used. Surprisingly, the presence of low type workers is beneficial: the efficient equilibrium exists only if the proportion of low type workers is not too small. The model generates rich empirical implications about the relationships among wages, turnover and tenure. The fourth chapter considers a repeated prisoner's dilemma game played by a community of players. After playing the component prisoner's dilemma game in some period, a player can choose to seek a new partner or to continue interacting with the same partner in the next period. Players come in three types: a player is either programmed to cheat, programmed to be honest, or is able to choose an action based on incentives. Pure and mixed strategy equilibria within the class of “simple equilibria” are derived. The heterogeneity of types helps sustain pure strategy equilibria with high average payoffs.

Subject Area

Economic theory

Recommended Citation

Yang, Huanxing, "Essays on relational contracts and repeated games" (2004). Dissertations available from ProQuest. AAI3138092.
https://repository.upenn.edu/dissertations/AAI3138092

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