Relational Contracts, Limited Liability, and Employment Dynamics

Yuk fai Fong, Jin Li

Research output: Working paper


This paper studies a relational contracting model in which the agent is protected by a limited liability constraint. The agent’s effort is his private information and affects the output stochastically. We characterize the optimal relational contract and compare the dynamics of the relationship with that under the optimal long-term contract. Under the optimal relational contract, the relationship is less likely to survive, and the surviving relationship is less efficient. In addition, relationships always converge to a steady state under the optimal long-term contract, but they can cycle among different phases under the optimal relational contract.
Original languageEnglish (US)
Number of pages50
StatePublished - Feb 6 2016


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