Short-Term Contracts and Long-Term Agency Relationships
Abstract Long-term contracts are valuable only if optimal contracting requires commitment to a plan today that would not otherwise be adopted tomorrow. We show that commitments are unnecessary, and hence short-term contracts are sufficient if (1) all public information can be used in contracting, (2) the agent can acess a bank on equal terms with the principal, (3) recontracting takes place with common knowledge about technology and preferences and (4) the frontier of expected utility payoffs generated by the set of incentive-compatible contracts is downward sloping at all times.