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REPEATED MORAL HAZARD' BY WILLIAM P. ROGERSON This paper considers a repeated principal agent relationship where the principal is risk neutral, the agent is risk averse, the principal can borrow or save at a fixed interest rate, and the agent discounts future consumption. It is shown that memory plays a very strong role in every Pareto-optimal contract. Sufficient conditions for Pareto-optimal contracts to exhibit rising or falling wages are identified. Finally, it is shown that the restriction of the agent's access to credit is necessary to achieve a Pareto-optimal outcome. In particular, under every Pareto-optimal contract for every outcome of every period the agent would choose to save some of his wage if he could.

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This paper considers the profit-maximization problem of a firm that must make sunk investments in long-lived assets to produce output. It is shown that if per-period accounting income is calculated using a simple and natural allocation rule for investment, called the relative replacement cost (RRC) rule, under a broad range of plausible circumstances, the firm can choose the fully optimal sequence of investments over time simply by choosing a level of investment each period in order to maximize the next period's accounting income. Furthermore, in a model in which shareholders delegate the investment decision to a better-informed manager, it is shown that if accounting income based on the RRC allocation rule is used as a performance measure for the manager, robust incentives are created for the manager to choose the profit-maximizing sequence of investments, regardless of the manager's own personal discount rate or other aspects of the manager's personal preferences. (c) 2008 by The University of Chicago. All rights reserved..