Setbacks Big and Small

Felix Zhiyu Feng, Curtis R. Taylor, Mark M. Westerfield, and Feifan Zhang
Working Paper, December 2025

[PDF] [SSRN Version]

Summary

We follow our previous work, Setbacks, Shutdowns, and Overruns (Econometrica, 2024), by allowing setbacks to have variable sizes. We show that the binding incentive constraint is a generalization of the “no-postponed-setback” constraint.

Abstract

We study the optimal incentive contract for a time-to-build project subject to both major and minor setbacks. Setbacks are flaws in the project, discovered (not caused) by the agent, and the size is privately observed by him. The agent can exploit this informational advantage to hide being behind schedule, generating persistent private information. We show that the optimal contract is governed by a family of “no-postponed-setback” constraints that imply a weakly higher likelihood of termination following larger reported setbacks. These constraints provide a straightforward organizing principle for the optimal contract and clarify how continuation utility is rationed across histories. Our analysis complements the all-or-nothing environment we studied in Setbacks, Shutdowns, and Overruns (Econometrica, 2024) and offers tractable tools for settings in which effort incentives interact with persistent private information.

Cite as

Feng, Felix Zhiyu, Curtis R. Taylor, Mark M. Westerfield, and Feifan Zhang. 2025. “Setbacks Big and Small.” Working paper, December 2025.

BibTeX

@unpublished{FengTaylorWesterfieldZhang2025,
  author = {Feng, Felix Zhiyu and Taylor, Curtis R. and Westerfield, Mark M. and Zhang, Feifan},
  title  = {Setbacks Big and Small},
  note   = {Working paper},
  month  = {December},
  year   = {2025},
  url    = {https://markwesterfield.com/papers/FTWZ-Setbacks-Big-Small.html}
}

This is a working paper; the posted PDF is the December 2025 draft. Updated October 5, 2026.