Relational Incentive Contracts with Persistent Private Information

Abstract

This paper investigates relational incentive contracts with a continuum of privatelyobserved agent types that are persistent over time. For a sufficiently productive relationship, a full pooling contract exists in which all agent types continuing the relationship choose the same action. When some separation is feasible, the parties can do better than with full pooling. When future actions are optimal, however, full separation of all types is not possible. There is, though, an equilibrium with separation into pools each containing a non-degenerate interval of types and fully separating individual types is not generally optimal. Separation results in an increase in output. Keywords: Relational incentive contracts, private information, ratchet effect, dynamic enforcement JEL classification: C73, D82, D86