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Probationary Contracts in Agencies with Bilateral Asymmetric Information

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  • Asha Sadanand
  • Venkatraman Sadanand
  • Denton Marks

Abstract

This paper examines a two-period principal and agent model where the agent's ability level is not observable to the principal and revealed to the agent only after the contract is signed. The value of the agent's output to the principal is affected by the agent's collegiality, which is unknown to the agent, but is observed by the principal. In these circumstances, with risk-neutral agents, the principal prefers a "probationary scheme" with second-period rehiring based on satisfactory first-period performance. Multiple equilibria results from this problem. However, the refinements literature provides a resolution to the multiplicity. Under certain conditions, the agent is rehired for sufficiently high first-period output; the superior agent will work harder in the first period than under recontracting, and the inferior-type agent will work less hard. The probationary scheme is shown to be Pareto superior to standard recontracting.

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Bibliographic Info

Article provided by Canadian Economics Association in its journal Canadian Journal of Economics.

Volume (Year): 22 (1989)
Issue (Month): 3 (August)
Pages: 643-61

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Handle: RePEc:cje:issued:v:22:y:1989:i:3:p:643-61

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Postal: Canadian Economics Association Prof. Steven Ambler, Secretary-Treasurer c/o Olivier Lebert, CEA/CJE/CPP Office C.P. 35006, 1221 Fleury Est Montréal, Québec, Canada H2C 3K4
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Cited by:
  1. Gerd Muehlheusser & Andrea Ichino, 2004. "How often should you open the door? Optimal monitoring to screen heterogeneous agents," Econometric Society 2004 North American Summer Meetings 60, Econometric Society.
  2. Fredrik Andersson, 2001. "Adverse selection and bilateral asymmetric information," Journal of Economics, Springer, vol. 74(2), pages 173-195, June.
  3. Sami, Hind, 2009. "Random monitoring in financing relationships," The Quarterly Review of Economics and Finance, Elsevier, vol. 49(2), pages 239-252, May.
  4. Glazer, Amihai, 2012. "Up-or-out policies when a worker imitates another," Journal of Economic Behavior & Organization, Elsevier, vol. 84(1), pages 432-438.
  5. Regina T. Riphahn & Anja Thalmaier, 2001. "Behavioral Effects of Probation Periods: An Analysis of Worker Absenteeism," Journal of Economics and Statistics (Jahrbuecher fuer Nationaloekonomie und Statistik), Justus-Liebig University Giessen, Department of Statistics and Economics, vol. 221(2), pages 179-201.

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