Managing Information and Incentives for Choice and Execution in Relational Contracts

Abstract: We consider a relational contracting model in which the project is selected by the party with authority before the agent exerts effort to execute the project. In order to induce the agent to exert effort, the principal controls the agent's confidence, defined as the belief on the project to be promising, through allocation of authority as well as pays discretionary bonuses. In contrast to the case where the agent has authority, allocating authority to the principal makes the agent's confidence uncertain that hinders effort for patient parties, but fosters effort for impatient parties. Consequently, authority is not necessarily allocated to the party with superior information.