Econometrica: May, 2023, Volume 91, Issue 3
Relational Contracts: Public versus Private Savings
Francesc Dilmé, Daniel F. Garrett
Work on relational employment agreements often predicts low payments or termination for poor performance. The possibility of saving can, however, limit the effectiveness of monetary incentives in motivating an employee with diminishing marginal utility for consumption. We study the role of savings and their observability in optimal relational contracts. We focus on the case where players are not too patient, and hence the constant first‐best effort cannot be implemented. If savings are hidden, the relationship eventually deteriorates over time. In particular, both payments and effort decline. On the other hand, if savings are public, consumption is initially high, so the agent's savings fall over time, and effort and payments to the agent increase. The findings thus suggest how tacit agreements on consumption can forestall the deterioration of dynamic relationships in which the agent can save.
Supplement to "Relational Contracts: Public versus Private Savings"
Francesc Dilmé and Daniel F. Garrett
This Online Appendix discusses anecdotal evidence of the importance of implicit agreements on high consumption levels in employment and other relationships. The findings in the observable consumption case (see Section 5) may shed light on the role of high consumption in these instances.