Optimal effort in the principal-agent problem with time-inconsistent preferences

This paper incorporates an agent’s time-inconsistent preferences into the Sannikov (2008) contract model to explore the effects of an agent’s preferences on his own behaviors: the incentive effort choice, the optimal retirement time and the consumption flow during his whole career life. We find the agent’s time inconsistency makes it difficult for him to be motivated and makes him need more compensation. An agent’s time-inconsistency erodes both the principal and his own income. The time-inconsistent agent will choose a lower incentive effort level, retire at an earlier time and have a lower consumption flow compared with his time-consistent peer. The time-inconsistent preference exactly influences the agents behavior and makes the agency problem more serious. Therefore, the firm has to cost more to stimulate such a time-inconsistent agent, which will damage the firms profits, as well as the efficiency.