IDEAS home Printed from https://ideas.repec.org/p/cpr/ceprdp/9956.html
   My bibliography  Save this paper

The Ratchet Effect Re-examined: A Learning Perspective

Author

Listed:
  • Bhaskar, Venkataraman

Abstract

We study dynamic moral hazard where principal and agent are symmetrically uncertain about job difficulty. Since effort is unobserved, shirking leads the principal to believe that the job is hard, increasing the agent's continuation value. So deterring shirking requires steeper incentives, which induce the agent to over-work today, since he can quit if the principal believes that the job is easy. With continuous effort choices, no interior effort is implementable in the first period. The agent's continuation value function is non-differentiable and convex, since the principal makes the agent indifferent between his discrete (participation) choices in the second period. The problem can be solved if the agent's participation decision is made continuous, or if there are long-term commitments, and we provide conditions for the first order approach to work. However, the impossibility result recurs in other agency models that combine discrete and continuous choices.

Suggested Citation

  • Bhaskar, Venkataraman, 2014. "The Ratchet Effect Re-examined: A Learning Perspective," CEPR Discussion Papers 9956, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:9956
    as

    Download full text from publisher

    File URL: https://cepr.org/publications/DP9956
    Download Restriction: CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Gustavo Manso, 2011. "Motivating Innovation," Journal of Finance, American Finance Association, vol. 66(5), pages 1823-1860, October.
    2. Johannes Hörner & Larry Samuelson, 2013. "Incentives for experimenting agents," RAND Journal of Economics, RAND Corporation, vol. 44(4), pages 632-663, December.
    3. Jewitt, Ian, 1988. "Justifying the First-Order Approach to Principal-Agent Problems," Econometrica, Econometric Society, vol. 56(5), pages 1177-1190, September.
    4. Meyer, Margaret A & Vickers, John, 1997. "Performance Comparisons and Dynamic Incentives," Journal of Political Economy, University of Chicago Press, vol. 105(3), pages 547-581, June.
    5. Dirk Bergemann & Ulrigh Hege, 2005. "The Financing of Innovation: Learning and Stopping," RAND Journal of Economics, The RAND Corporation, vol. 36(4), pages 719-752, Winter.
    6. Richard A. Lambert, 1983. "Long-Term Contracts and Moral Hazard," Bell Journal of Economics, The RAND Corporation, vol. 14(2), pages 441-452, Autumn.
    7. Innes, Robert D., 1990. "Limited liability and incentive contracting with ex-ante action choices," Journal of Economic Theory, Elsevier, vol. 52(1), pages 45-67, October.
    8. Xavier Freixas & Roger Guesnerie & Jean Tirole, 1985. "Planning under Incomplete Information and the Ratchet Effect," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 52(2), pages 173-191.
    9. Lazear, Edward P, 1986. "Salaries and Piece Rates," The Journal of Business, University of Chicago Press, vol. 59(3), pages 405-431, July.
    10. Bergemann, Dirk & Hege, Ulrich, 1998. "Venture capital financing, moral hazard, and learning," Journal of Banking & Finance, Elsevier, vol. 22(6-8), pages 703-735, August.
    11. Carmichael, H Lorne & MacLeod, W Bentley, 2000. "Worker Cooperation and the Ratchet Effect," Journal of Labor Economics, University of Chicago Press, vol. 18(1), pages 1-19, January.
    12. Gibbons, Robert & Murphy, Kevin J, 1992. "Optimal Incentive Contracts in the Presence of Career Concerns: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 100(3), pages 468-505, June.
    13. Philippe Jehiel & Olivier Compte, 2007. "On Quitting Rights in Mechanism Design," American Economic Review, American Economic Association, vol. 97(2), pages 137-141, May.
    14. Gibbons, Robert, 1987. "Piece-Rate Incentive Schemes," Journal of Labor Economics, University of Chicago Press, vol. 5(4), pages 413-429, October.
    15. Paul Milgrom & Ilya Segal, 2002. "Envelope Theorems for Arbitrary Choice Sets," Econometrica, Econometric Society, vol. 70(2), pages 583-601, March.
    16. Barry W. Ickes & Larry Samuelson, 1987. "Job Transfers and Incentives in Complex Organizations: Thwarting the Ratchet Effect," RAND Journal of Economics, The RAND Corporation, vol. 18(2), pages 275-286, Summer.
    17. Jean-Jacques Laffont & Jean Tirole, 1993. "A Theory of Incentives in Procurement and Regulation," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262121743, December.
    18. Mathias Dewatripont & Ian Jewitt & Jean Tirole, 1999. "The Economics of Career Concerns, Part I: Comparing Information Structures," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 66(1), pages 183-198.
    19. Rogerson, William P, 1985. "Repeated Moral Hazard," Econometrica, Econometric Society, vol. 53(1), pages 69-76, January.
    20. Bengt Holmström, 1999. "Managerial Incentive Problems: A Dynamic Perspective," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 66(1), pages 169-182.
    21. repec:oup:restud:v:84:y::i:1:p:182-236. is not listed on IDEAS
    22. Laffont, Jean-Jacques & Tirole, Jean, 1988. "The Dynamics of Incentive Contracts," Econometrica, Econometric Society, vol. 56(5), pages 1153-1175, September.
    23. Mathias Dewatripont & Ian Jewitt & Jean Tirole, 1999. "The Economics of Career Concerns, Part I: Comparing Information Structures," Review of Economic Studies, Oxford University Press, vol. 66(1), pages 183-198.
    24. Bengt Holmstrom, 1999. "Managerial Incentive Problems: A Dynamic Perspective," NBER Working Papers 6875, National Bureau of Economic Research, Inc.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Bhaskar, V. & Mailath, George J., 2019. "The curse of long horizons," Journal of Mathematical Economics, Elsevier, vol. 82(C), pages 74-89.
    2. Pollrich, Martin & Schmidt, Robert, 2014. "An optimal incentive contract to avert firm relocation," VfS Annual Conference 2014 (Hamburg): Evidence-based Economic Policy 100314, Verein für Socialpolitik / German Economic Association.
    3. Cetemen, Doruk & Hwang, Ilwoo & Kaya, Ayça, 2020. "Uncertainty-driven cooperation," Theoretical Economics, Econometric Society, vol. 15(3), July.
    4. repec:bdp:wpaper:2014004 is not listed on IDEAS
    5. Sofia Moroni, 2016. "Experimentation in Organizations," Working Paper 5876, Department of Economics, University of Pittsburgh.
    6. Martin Pollrich & Robert Schmidt, 2015. "Unobservable investments, limited commitment, and the curse of firm relocation," BDPEMS Working Papers 1, Berlin School of Economics.
    7. Sofia Moroni, 2019. "Experimentation in Organizations," Working Paper 6631, Department of Economics, University of Pittsburgh.
    8. Arie, Guy, 2016. "Dynamic costs and moral hazard: A duality-based approach," Journal of Economic Theory, Elsevier, vol. 166(C), pages 1-50.
    9. Cardella, Eric & Depew, Briggs, 2016. "Testing for the Ratchet Effect: Evidence from a Real-Effort Work Task," IZA Discussion Papers 9981, Institute of Labor Economics (IZA).
    10. Cardella, Eric & Depew, Briggs, 2018. "Output restriction and the ratchet effect: Evidence from a real-effort work task," Games and Economic Behavior, Elsevier, vol. 107(C), pages 182-202.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Bhaskar, V. & Mailath, George J., 2019. "The curse of long horizons," Journal of Mathematical Economics, Elsevier, vol. 82(C), pages 74-89.
    2. Bhaskar, Venkataraman, 2012. "Dynamic Moral Hazard, Learning and Belief Manipulation," CEPR Discussion Papers 8948, C.E.P.R. Discussion Papers.
    3. Gary Charness & Peter Kuhn & Marie Claire Villeval, 2011. "Competition and the Ratchet Effect," Journal of Labor Economics, University of Chicago Press, vol. 29(3), pages 513-547.
    4. Cardella, Eric & Depew, Briggs, 2016. "Testing for the Ratchet Effect: Evidence from a Real-Effort Work Task," IZA Discussion Papers 9981, Institute of Labor Economics (IZA).
    5. Korok Ray, 2007. "Performance Evaluations and Efficient Sorting," Journal of Accounting Research, Wiley Blackwell, vol. 45(4), pages 839-882, September.
    6. Cardella, Eric & Depew, Briggs, 2018. "Output restriction and the ratchet effect: Evidence from a real-effort work task," Games and Economic Behavior, Elsevier, vol. 107(C), pages 182-202.
    7. Gao, Hong & Xu, Haibo, 2020. "Learning, belief manipulation and optimal relationship termination," Economics Letters, Elsevier, vol. 190(C).
    8. Martinez Leonardo, 2009. "Reputation, Career Concerns, and Job Assignments," The B.E. Journal of Theoretical Economics, De Gruyter, vol. 9(1), pages 1-29, May.
    9. Daniel Garrett & Alessandro Pavan, 2009. "Dynamic Managerial Compensation: a Mechanism Design Approach," Carlo Alberto Notebooks 127, Collegio Carlo Alberto.
    10. Byford, Martin C., 2017. "Moral hazard in strategic decision making," International Journal of Industrial Organization, Elsevier, vol. 55(C), pages 114-136.
    11. Alex Edmans & Xavier Gabaix, 2016. "Executive Compensation: A Modern Primer," Journal of Economic Literature, American Economic Association, vol. 54(4), pages 1232-1287, December.
    12. Atif Mian, 2008. "Incentives in Markets, Firms, and Governments," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 24(2), pages 273-306, October.
    13. Leonardo Martinez, 2006. "Reputation and Career Concerns," 2006 Meeting Papers 853, Society for Economic Dynamics.
    14. Botond Koszegi & Wei Li, 2002. "Ambition and Talent," CERS-IE WORKING PAPERS 0214, Institute of Economics, Centre for Economic and Regional Studies.
    15. Jacques Crémer, 2010. "Arm's-Length Relationships without Moral Hazard," Journal of the European Economic Association, MIT Press, vol. 8(2-3), pages 377-387, 04-05.
    16. Patrick W. Schmitz, 2005. "Allocating Control in Agency Problems with Limited Liability and Sequential Hidden Actions," RAND Journal of Economics, The RAND Corporation, vol. 36(2), pages 318-336, Summer.
    17. Edward P. Lazear, 1995. "Personnel Economics," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262121883, December.
    18. W. Bentley MacLeod, 2006. "Reputations, Relationships and the Enforcement of Incomplete Contracts," CESifo Working Paper Series 1730, CESifo.
    19. Martin Byford, 2003. "Moral Hazard From Costless Hidden Actions," Working Papers 2003.03, School of Economics, La Trobe University.
    20. Bilanakos, Christos, 2013. "Career concerns and firm – sponsored general training," Research in Economics, Elsevier, vol. 67(2), pages 117-132.

    More about this item

    Keywords

    Ratchet effect; Moral hazard; Learning; Envelope theorem; First-order approach;
    All these keywords.

    JEL classification:

    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:cpr:ceprdp:9956. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: the person in charge (email available below). General contact details of provider: https://www.cepr.org .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.