The "Ratchet Principle" and Performance Incentives
AbstractThe use of current performance as a partial basis for setting future targets is an almost universal feature of economic planning. This "ratchet principle," as it is sometimes called, creates a dynamic incentive problem for the enterprise. Higher rewards from better current performance must be weighed against the future assignment of more ambitious targets. In this paper I formulate the problem of the enterprise as a multiperiod stochastic optimization model incorporating an explicit feedback mechanism for target setting. I show that an optimal solution is easily characterized, and that the incentive effects of the ratchet principle can be fully analyzed in simple economic terms.
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Bibliographic InfoArticle provided by The RAND Corporation in its journal Bell Journal of Economics.
Volume (Year): 11 (1980)
Issue (Month): 1 (Spring)
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- M. Weitzman, 1979. "The 'Ratchet Principle' and Performance Incentives," Working papers 239, Massachusetts Institute of Technology (MIT), Department of Economics.
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