On Inducing Agents with Term Limits to Take Appropriate Risk

A principal needs agents to appropriately select a risky action over a safe one, with replacement as the only incentivizing tool. Agents wish solely to re- main in office and the risky action can reveal his decision-making competence. Aghion and Jackson (2017) show how the inability to commit to a retention pol- icy severely limits the principal’s welfare. We study this problem when agents face two-period term limits and find that this helps the principal considerably. The term limit structure allows the principal to mimic the ability to make commitments and enforce a random dismissal rule following the safe action. The incentive problem becomes even less severe if the agent has private information about his competence and the stakes are high.