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Dynamic contracting with limited commitment and the ratchet effect

Author

Listed:
  • Gerardi, Dino

    (Collegio Carlo Alberto)

  • Maestri, Lucas

    (FGV/EPGE)

Abstract

We study dynamic contracting with adverse selection and limited commitment. A firm (the principal) and a worker (the agent) interact for potentially infinitely many periods. The worker is privately informed about his productivity and the firm can only commit to short-term contracts. The ratchet effect is in place since the firm has the incentive to change the terms of trade and offer more demanding contracts when it learns that the worker is highly productive. As the parties become arbitrarily patient, the equilibrium outcome takes one of two forms. If the prior probability of the worker being productive is low, the firm offers a pooling contract and no information is ever revealed. In contrast, if this prior probability is high, the firm fires the unproductive worker at the very beginning of the relationship.

Suggested Citation

  • Gerardi, Dino & Maestri, Lucas, 2020. "Dynamic contracting with limited commitment and the ratchet effect," Theoretical Economics, Econometric Society, vol. 15(2), May.
    • Handle: RePEc:the:publsh:2449
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    Cited by:

    1. Beccuti, Juan & Möller, Marc, 2021. "Screening by mode of trade," Games and Economic Behavior, Elsevier, vol. 129(C), pages 400-420.
    2. Juan Beccuti, 2020. "On the Optimality of Price-posting in Rental Markets," Diskussionsschriften dp2007, Universitaet Bern, Departement Volkswirtschaft.
    3. Subir K. Chakrabarti & Jaesoo Kim, 2023. "Optimal equilibrium contracts in the infinite horizon with no commitment across periods," Theory and Decision, Springer, vol. 94(3), pages 379-404, April.
    4. Bhaskar, V. & Mailath, George J., 2019. "The curse of long horizons," Journal of Mathematical Economics, Elsevier, vol. 82(C), pages 74-89.
    5. Ekmekci, Mehmet & Maestri, Lucas, 2019. "Reputation and screening in a noisy environment with irreversible actions," MPRA Paper 100885, University Library of Munich, Germany.
    6. Doval, Laura & Skreta, Vasiliki, 2024. "Optimal mechanism for the sale of a durable good," Theoretical Economics, Econometric Society, vol. 19(2), May.
    7. S. Nageeb Ali & Navin Kartik & Andreas Kleiner, 2023. "Sequential Veto Bargaining With Incomplete Information," Econometrica, Econometric Society, vol. 91(4), pages 1527-1562, July.
    8. Laura Doval & Vasiliki Skreta, 2022. "Mechanism Design With Limited Commitment," Econometrica, Econometric Society, vol. 90(4), pages 1463-1500, July.
    9. Ekmekci, Mehmet & Maestri, Lucas, 2022. "Wait or act now? Learning dynamics in stopping games," Journal of Economic Theory, Elsevier, vol. 205(C).
    10. Francisco Silva, 2020. "Self-evaluations," Documentos de Trabajo 554, Instituto de Economia. Pontificia Universidad Católica de Chile..
    11. Breig, Zachary, 2022. "Repeated contracting without commitment," Journal of Economic Theory, Elsevier, vol. 204(C).
    12. Mehmet Ekmekci & Lucas Maestri & Dong Wei, 2024. "Turning the Ratchet: Dynamic Screening with Multiple Agents," Papers 2405.04468, arXiv.org, revised Mar 2025.
    13. Malcomson, James M., 2025. "Grouping agents with persistent types," Games and Economic Behavior, Elsevier, vol. 152(C), pages 150-174.
    14. Mikhail Golosov & Luigi Iovino, 2021. "Social Insurance, Information Revelation, and Lack of Commitment," Journal of Political Economy, University of Chicago Press, vol. 129(9), pages 2629-2665.
    15. Martino Banchio & Frank Yang, 2021. "Dynamic Pricing with Limited Commitment," Papers 2102.07742, arXiv.org, revised Dec 2021.
    16. Awad, Emiel & Judd, Gleason & Riquelme, Nicolas, 2024. "Learning by Lobbying," SocArXiv 834vd, Center for Open Science.
    17. Ambec, Stefan & Coria, Jessica, 2021. "The informational value of environmental taxes," Journal of Public Economics, Elsevier, vol. 199(C).
    18. Johannes Abeler & David Huffman & Colin Raymond, 2023. "Incentive Complexity, Bounded Rationality and Effort Provision," Economics Series Working Papers 1012, University of Oxford, Department of Economics.
    19. Gao, Hong & Xu, Haibo, 2020. "Learning, belief manipulation and optimal relationship termination," Economics Letters, Elsevier, vol. 190(C).
    20. Brzustowski, Thomas & Georgiadis Harris, Alkis & Szentes, Balázs, 2023. "Smart contracts and the Coase conjecture," LSE Research Online Documents on Economics 117950, London School of Economics and Political Science, LSE Library.
    21. Jeitschko, Thomas D. & Withers, John A., 2019. "Dynamic regulation revisited: Signal dampening, experimentation and the ratchet effect," DICE Discussion Papers 318, Heinrich Heine University Düsseldorf, Düsseldorf Institute for Competition Economics (DICE).
    22. Suehyun Kwon, 2019. "Informed-Principal Problem in Mechanisms with Limited Commitment," CESifo Working Paper Series 7513, CESifo.
    23. Abeler, Johannes & Huffman, David B. & Raymond, Collin, 2023. "Incentive Complexity, Bounded Rationality and Effort Provision," IZA Discussion Papers 16284, Institute of Labor Economics (IZA).
    24. Suehyun Kwon, 2019. "Revelation Principle with Persistent Correlated Types: Impossibility Result," CESifo Working Paper Series 7782, CESifo.
    25. Alessandro Bonatti & Gonzalo Cisternas, 2020. "Consumer Scores and Price Discrimination," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 87(2), pages 750-791.

    More about this item

    Keywords

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    JEL classification:

    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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