Myopic Agency

I consider a repeated principal-agent setting in which the agent repeatedly chooses between hidden “long-term” and “short-term” actions. Relative to the long-term action, the short-term action boosts output today but hurts output tomorrow. The optimal contract inducing long-term actions provides a fresh perspective on upward sloping pay scales, severance pay and high-watermark contracts. The myopic agency model is unlike traditional agency models that ignore action persistence. I show ignoring action persistence can significantly distort optimality. For example, traditional optimal contracts typically reward something like high average output whereas the myopic agency optimal contract rewards sustained high output. JEL Codes: C73, D86, J33, J41, M52 [email protected], The Wharton School, University of Pennsylvania. I thank Daniel Neuhann for excellent research assistance and Richard Kihlstrom for providing valuable guidance throughout the development of the paper. I am grateful to Robert Anderson, Alex Edmans, Mike Fishman, Itay Goldstein, Ben Hermalin, Steven Matthews, Andy Postlewaite, Andy Skrzypacz, Rob Stambaugh and Bilge Yilmaz for comments and advice. Lastly I would like to thank the seminar participants at the University of Pennsylvania, 2012 NBER/NSF/CEME Conference on Mathematical Economics and General Equilibrium Theory, and Northwestern Finance for helpful feedback.