We study a dynamic contracting problem in which size is relevant. The agent may take on excessive risk to enhance short-term gains, which exposes the principal to large, infrequent losses. To preserve incentive compatibility, the optimal contract uses size as an instrument; there is downsizing...

We study a continuous-time contracting problem in which size plays a role. The agent may take on excessive risk to enhance short-term gains; doing so exposes the principal to large, infrequent losses. The optimal contract includes size as an instrument: downsizing along the equilibrium path may...