We consider how a firm's policies constrain its relational contracts. A policy is a sequence of decisions made by a principal; each decision determines how agents' efforts affect their outputs. We consider surplus-maximizing policies in a flexible dynamic moral hazard problem between a principal and several agents with unrestricted vertical transfers and no commitment. If agents cannot coordinate to punish the principal following a deviation, then the principal might optimally implement dynamically inefficient, history-dependent policies to credibly reward high-performing agents. We develop conditions under which such backward-looking policies are surplus-maximizing and illustrate how they influence promotions, hiring, and performance.
Barron, Daniel, and Michael Powell.
"Policies in Relational Contracts."
American Economic Journal: Microeconomics,
Firm Behavior: Theory
Asymmetric and Private Information; Mechanism Design
Economics of Contract: Theory
Personnel Economics: Firm Employment Decisions; Promotions