Dynamic Contracting: An Irrelevance Result

Abstract

This paper considers a general, dynamic contracting problem with adverse selection and moral hazard, in which the agent’s type stochastically evolves over time. The agent’s final payoff depends on the entire history of private and public information, contractible decisions and the agent’s hidden actions, and it is linear in the transfer between her and the principal. We transform the model into an equivalent one where the agent’s subsequent information is independent in each period. Our main result is that for any fixed decision-action rule implemented by a mechanism, the maximal expected revenue that the principal can obtain is the same as if the principal could observe the agent’s orthogonalized types after the initial period. In this sense, the dynamic nature of the relationship is irrelevant: the agent only receives information rents for her initial private information. We also show that any monotonic decision-action rule can be implemented in a Markov environment satisfying certain regularity conditions.