Contract Prolongation In Innovation Production As A Principal-Agent Problem With Moral Hazard

We consider the problem between an employer and a research employee who has not finished a research project in time because of a lack of an innovative idea. The research project yields money in case of finishing it. The decision to be made is whether or not the researcher gets a contract prolongation. Giving him or her a prolongation is associated with a positive expected return for the employer, which may or may not exceed the expected costs of the prolongation. A principal-agent problem is formulated, in which the probability of success is determined by the research time allotted and the effort of the agent. The agent decides upon his effort given the salary (reduction), the share of research time, and the length of the prolongation. The employer takes a decision on these variables, knowing the agent’s first-order condition with respect to effort. For the decision on the length of the contract prolongation it is of crucial importance what impact the research-time share (or the teaching load) has on the probability density of success and on the effort chosen by the agent. All theoretically possible outcomes are discussed. In particular the decision of the faculty of economics at Maastricht University, not to give any prolongation, is discussed in terms of the model.