Abstract

We present a model of relationalincentive contract where the extent of worker discretion oscillates over timeas the firm faces private liquidity shocks. Workers with discretion adapt theiractions to ensure production efficiency but require strong incentives. But asshocks weaken relational incentives, the firm may standardize the work processby implementing rules that yield a satisfactory performance. Standardizationhelps the relationship survive the shocks at present, but makes it lessefficient and more vulnerable in future. While the relationship may recover,its ability to weather future shocks deteriorates.