I show that deterministic dynamic contracts between a principal and an agent are always at least as profitable to the principal as stochastic ones, if the so-called first-order approach in dynamic mechanism design is satisfied. The principal commits, while the agent's type evolution follows a Markov process. My results demonstrate, even when allowing for potential correlation of stochastic contracts across periods that the usual restriction in the literature to deterministic contracts is admissible, as long as the first-order approach is valid.
This paper studies a canonical dynamic screening problem where the agent has Markovian private information and limited commitment and the principal and the agent have different discount factors. Unequal discounting captures unequal access to capital markets. In comparison to standard models of dynamic mechanism design, the principal no longer finds it optimal to maximally back-load the agent’s information rents: a new force of inter-temporal cost of incentive provision pushes toward front-loading agents’ payoffs. The optimal contract settles into a cycle with infinite memory. The introduction of unequal discounting renders the standard relaxed-problem approach invalid for certain parameters. A simple and approximately optimal contract is then provided. (JEL D21, D61, D82, D86, L14)
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