COMPARATIVE STATICS OF THE OPTIMAL DYNAMIC INCENTIVE CONTRACT

Each period a firm must carry out an indivisible project, the cost of which depends on the firm's constant efficiency and its (variable) level of 'effort'. Only the cost is observed by the regulator who has to choose the incentive scheme. The optimal dynamic mechanism is derived under possible commitment of the regulator over time. Then, under non-commitment, it is shown that there are four types of continuation equilibria. Also the profile of effort levels is compared to the commitment case. Finally, some numerical comparative statics is performed and it is shown that all types of equilibria can be optimal. © 1987.