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  3. American Economic Journal: Microeconomics
  4. November 2019
  5. Relational Contracts with Private Information on the Future Value of the Relationship: The Upside of Implicit Downsizing Costs

Relational Contracts with Private Information on the Future Value of the Relationship: The Upside of Implicit Downsizing Costs

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Abstract

We analyze a relational-contracting problem, in which the principal has private information about the future value of the relationship. In order to reduce bonus payments, the principal is tempted to claim that the value of the future relationship is lower than it actually is. To induce truth-telling, the optimal relational contract may introduce distortions after a bad report. For some levels of the discount factor, output is reduced by more than would be sequentially optimal. This distortion is attenuated over time even if prospects remain bad. Our model thus provides an alternative explanation for indirect short-run costs of downsizing.

Citation

Fahn, Matthias, and Nicolas Klein. 2019. "Relational Contracts with Private Information on the Future Value of the Relationship: The Upside of Implicit Downsizing Costs." American Economic Journal: Microeconomics, 11 (4): 33-58. DOI: 10.1257/mic.20170294

Additional Materials

JEL Classification

  • D23 Organizational Behavior; Transaction Costs; Property Rights
  • D82 Asymmetric and Private Information; Mechanism Design
  • D86 Economics of Contract: Theory
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