A large supplier (principal) contracts with a small firm (agent) to repeatedly provide working capital in return for payments. The total factor productivity of the agent is private and follows a Markov process. Moreover, the agent is less patient than the principal. We solve for the optimal...

We explore the conditions under which the "first-order approach" (FO-approach) can be used to characterize profit maximizing contracts in dynamic principal-agent models. The FO-approach works when the resulting FO-optimal contract satisfies a particularly strong form of monotonicity in types, a...