When to behave badly and when to behave well under disagreement

With Alexandra Charbi

Abstract: In a repeated principal-agent problem in which the agent has private information about her i.i.d. cost of effort (à la Levin 2003), we analyze relational contracts that the parties can renegotiate in a way that respects their relative bargaining power. We show that if a disagreement arises in a state in which she was to be rewarded, then it is optimal for the agent to destroy surplus, exerting costly effort to hurt the principal. In such an event, her counter-productive effort is optimally constant regardless of her effort cost, the principal does not fire her, and both parties anticipate agreeing to reward the agent in the next period. In contrast, on the equilibrium path as well as under disagreement in a state in which the agent was to be punished, the agent exerts productive effort that is decreasing in her effort cost.

Working paper 6/6/2016