Dynamic contracting with limited liability constraints
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Citation (published version)Juan Ortner, Edoardo Grillo. "Dynamic contracting with limited liability constraints." Working paper. 19 pages.
We study a dynamic mechanism design problem in which a buyer seeks to procure an item from a single seller in multiple periods. The seller is privately informed about her procurement cost at each period, and this cost may be serially correlated over time. We restrict the buyer to use mechanisms satisfying a limited liability constraint: the seller’s flow payoffs must be non-negative at each period. Limited liability constraints give rise to new dynamic distortions and inefficiencies.The optimal mechanism is path dependent, favoring sellers who had low cost realizations in the past.