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Probationary Contracts in Agencies with Bilateral Asymmetric Information

Author

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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.

Suggested Citation

  • Asha Sadanand & Venkatraman Sadanand & Denton Marks, 1989. "Probationary Contracts in Agencies with Bilateral Asymmetric Information," Canadian Journal of Economics, Canadian Economics Association, vol. 22(3), pages 643-661, August.
    • Handle: RePEc:cje:issued:v:22:y:1989:i:3:p:643-61
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    Cited by:

    1. Glazer, Amihai, 2012. "Up-or-out policies when a worker imitates another," Journal of Economic Behavior & Organization, Elsevier, vol. 84(1), pages 432-438.
    2. Sami, Hind, 2009. "Random monitoring in financing relationships," The Quarterly Review of Economics and Finance, Elsevier, vol. 49(2), pages 239-252, May.
    3. Ichino, Andrea & Muehlheusser, Gerd, 2008. "How often should you open the door?: Optimal monitoring to screen heterogeneous agents," Journal of Economic Behavior & Organization, Elsevier, vol. 67(3-4), pages 820-831, September.
    4. Riphahn Regina T. & Thalmaier Anja, 2001. "Behavioral Effects of Probation Periods: An Analysis of Worker Absenteeism / Anreizeffekte der Probezeit: Eine Untersuchung von Fehlzeiten bei Arbeitnehmern," Journal of Economics and Statistics (Jahrbuecher fuer Nationaloekonomie und Statistik), De Gruyter, vol. 221(2), pages 179-201, April.
    5. Panu Poutvaara & Tuomas Takalo & Andreas Wagener, 2017. "The Optimal Duration of Contracts," CESifo Working Paper Series 6808, CESifo.
    6. Riphahn, Regina T. & Thalmaier, Anja, 1999. "Behavioral Effects of Probation Periods: An Analysis of Worker Absenteeism," IZA Discussion Papers 67, Institute of Labor Economics (IZA).
    7. Fredrik Andersson, 2001. "Adverse selection and bilateral asymmetric information," Journal of Economics, Springer, vol. 74(2), pages 173-195, June.

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