Optimal Incentives in Dynamic Multiple Project Contracts

We design a multiple project-funding contract that provides optimal incentives to recipients, in a setting where externalities exist among the multiple projects and where donors and recipients may differ in their valuation of the projects. To do so, we study optimal incentive payments in a dynamic principal-agent framework with focus on two-project contracts. The principal cannot observe the agent’s investment, but only completed projects. We consider principals that cannot commit to contract termination before completion of the projects; we assume that the contract does not end until both projects are accomplished. We derive the optimal contract for each possible combination of principal-agentproject characteristics to find that projects should be undertaken simultaneously when value externalities among them are large, i.e. when completing both projects gives the recipient significantly more utility than the sum of the projects’ independent values. The principal’s utility maximizing strategy, when technical externalities among projects are important, is a sequential contract that starts with the project that generates the externality. We find that differences in project valuation between agents and recipients may, in some cases, lead to inefficient contracts, when in other situations the ability of the principal to choose the timing of the project competition may be a safety clause for him.