@article{7c3cd38521ce41ae8141f1385d040140,
title = "Dynamic mechanism design with hidden income and hidden actions",
abstract = "We develop general recursive methods to solve for optimal contracts in dynamic principal-agent environments with hidden states and hidden actions. Starting from a general mechanism with arbitrary communication, randomization, full history dependence, and without restrictions on preferences or technology, we show that the optimal contract can be implemented as a recursive direct mechanism. A curse of dimensionality which arises from the interaction of hidden income and hidden actions can be overcome by introducing utility bounds for behavior off the equilibrium path. Environments with multiple actions are implemented using multiple layers of such off-path utility bounds.",
keywords = "Dynamic contracts, Mechanism design, Recursive contracts",
author = "Matthias Doepke and Townsend, {Robert M.}",
note = "Funding Information: We are grateful to Harold Cole, Hugo Hopenhayn, Ken Judd, Marek Kapicka, Lars Ljungqvist, Roger Myerson, Nicola Pavoni, Ned Prescott, Phil Reny, Tom Sargent, Steve Tadelis, Iv{\'a}n Werning, Ruilin Zhou, and seminar participants at Boston University, Chicago, Cleveland Fed, Gerzensee, IIES, MIT, Richmond Fed, Stanford, UCL, UCLA, UC San Diego, the SED meeting in San Jos{\'e}, and the SIEPR Conference on “Credit Market Frictions in the Macroeconomy” for helpful comments. We also thank the co-editor and two anonymous referees for suggestions that substantially improved the paper. Matthias Doepke acknowledges support by the NSF (Grant SES-0217051), and Robert Townsend was supported by the NSF (Grant 318340) and the NICHD (Grant R01 HD027638).",
year = "2006",
month = jan,
doi = "10.1016/j.jet.2004.07.008",
language = "English (US)",
volume = "126",
pages = "235--285",
journal = "Journal of Economic Theory",
issn = "0022-0531",
publisher = "Academic Press Inc.",
number = "1",
}