Dynamic Communication with Commitment

I study the optimal communication problem in a dynamic principal-agent model. The agent observes the evolution of an imperfectly persistent state, and makes unverifiable reports of the state over time. The principal takes actions based solely on the agent’s reports, with commitment to a dynamic contract in the absence of transfers. Interests are misaligned: while the agent always prefers higher levels of action to lower, the principal’s ideal action is state-dependent. In a one-shot interaction, the agent’s information can never be utilized by the principal. In contrast, I show that communication can be effective in dynamic interactions, and I find a new channel, the information sensitivity, that makes dynamic communication effective. Moreover, I derive a closed-form solution for the optimal contract. I find that the optimal contract can display two properties new to the literature: contrarian allocation, and delayed response. I also provide a necessary and sufficient condition under which these properties arise. The results can be applied to practical problems such as capital budgeting between a headquarters and a division manager, or resource allocation between the central government and a local government.