Time-inconsistent contract theory

Abstract: This paper investigates the moral hazard problem in finite horizon with both continuous and lump-sum payments, involving a time-inconsistent sophisticated agent and a standard utility maximiser principal. Building upon the so-called dynamic programming approach in Cvitani\'c, Possama\"i, and Touzi [18] and the recently available results in Hern\'andez and Possama\"i [43], we present a methodology that covers the previous contracting problem. Our main contribution consists in a characterisation of the moral hazard problem faced by the principal. In particular, it shows that under relatively mild technical conditions on the data of the problem, the supremum of the principal's expected utility over a smaller restricted family of contracts is equal to the supremum over all feasible contracts. Nevertheless, this characterisation yields, as far as we know, a novel class of control problems that involve the control of a forward Volterra equation via Volterra-type controls, and infinite-dimensional stochastic target constraints. Despite the inherent challenges associated to such a problem, we study the solution under three different specifications of utility functions for both the agent and the principal, and draw qualitative implications from the form of the optimal contract. The general case remains the subject of future research.