Dynamic Contracting With Unobserved Progress

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Doctor of Philosophy (PhD)
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This thesis investigates agency problems in projects whereas the principal cannot effectively monitor the progress. In Chapter 2, the baseline model is studied. It is assumed that the success of innovation requires an intermediate breakthrough and a final breakthrough, but the occurrence of the intermediate breakthrough is privately known to the agent. The principal provides incentives to the agent through a termination date and a reward for the final success. Two properties of optimal contracts are identified. First, conditional on the termination date, the optimal contract induces efficient actions from the agent. Second, the reward for success to the agent is in general non-monotone in success time and later success may be rewarded more. In Chapter 3, I consider several modifications to the modeling assumptions and discuss their implications. First, I study the case that the two breakthroughs need not be in a particular order, and the agent can choose which task to work on first. It is shown that it is optimal to induce the agent to work on the more difficult task first. Second, I consider the scenario where there is an ex ante probability that the project is a bad one and breakthroughs never come. The optimal contract is no longer efficient conditional on the termination date. Last, I allow the principal to receive informative signals on whether the intermediate breakthrough has occurred. In Chapter 4, I extend the baseline model by introducing randomly arriving buyers and apply it to study the financing of startup firms with opportunities to be acquired. I show that the potential acquisition increases the cost of providing incentives. Since an agent with low level of progress is ``bailed out" when an offer is made to acquire firms with both high and low levels of progress, the agent has more incentive to shirk. In response, the principal reduces the likelihood that the firm with high level of progress is sold. Moreover, the total financing provided by the principal is less compared to the environment without buyers.

George J. Mailath
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