Relational Incentive Contracts with Private Information

This paper extends the relational contract model in Levin (2003) with shocks to theagent’s cost of effort (agent’s type) to shocks to the principal’s valuation of the agent’seffort (principal’s type). When optimal effort is fully pooled across agent types formultiple principal types, it is also pooled across those principal types. When optimaleffort separates some agent types for multiple principal types, it is not generally fullypooled across those principal types. But somewhat perversely, effort is then lower forsome principal type for which it is more valuable. Implications for employment andsupply relationships are discussed.