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Working Paper
Optimal Incentive Contracts with Job Destruction Risk
We study the implications of job destruction risk for optimal incentives in a long-term contract with moral hazard. We extend the dynamic principal-agent model of Sannikov (2008) by adding an exogenous Poisson shock that makes the match between the firm and the agent permanently unproductive. In modeling job destruction as an exogenous Poisson shock, we follow the Diamond-Mortensen-Pissarides search-and-matching literature. The optimal contract shows how job destruction risk is shared between the rm and the agent. Arrival of the job-destruction shock is always bad news for the rm but can be ...