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The Ratchet Effect Re-examined: A Learning Perspective

Listed author(s):
  • Bhaskar, Venkataraman

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.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 9956.

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Date of creation: May 2014
Handle: RePEc:cpr:ceprdp:9956
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  1. Gustavo Manso, 2011. "Motivating Innovation," Journal of Finance, American Finance Association, vol. 66(5), pages 1823-1860, October.
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  15. 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.
  16. 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, January.
  17. Philippe Jehiel & Olivier Compte, 2007. "On Quitting Rights in Mechanism Design," American Economic Review, American Economic Association, vol. 97(2), pages 137-141, May.
  18. 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.
  19. Rogerson, William P, 1985. "Repeated Moral Hazard," Econometrica, Econometric Society, vol. 53(1), pages 69-76, January.
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