Penalizing Success in Dynamic Incentive Contracts: No. Good Deed Goes Unpunished?

Tracy Lewis and David Sappington

RAND Journal of Economics, 1997, vol. 28, issue 2, 346-358

Abstract: We examine optimal dynamic incentive contracts when adverse selection and moral hazard problems are present. We find that early success is optimally penalized in the sense that the agent who succeeds early subsequently faces a lower-powered incentive contract. Penalizing success in this manner serves to limit the agent's initial incentive to understate his ability.

Date: 1997
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