Moral Hazard and Long Run Incentives

Abstract

This paper considers dynamic moral hazard settings, in which the agent's actions have consequences over a long horizon. The agent's limited liability constraints makes it dicult to tie the agent's compensation to long-run outcomes. To maintain incen- tives, the optimal contract delays the agent's compensation and ties it to future performance. Some of the agent's compensation is deferred past termination, which is triggered when the value of deferred compensation drops to a specic, strictly positive thresh- old. The agent's pay-performance sensitivity, and therefore risk exposure, build up towards a target level during employment, and decrease after termination.