Dynamic Contracting with Limited Commitment and the Ratchet Effect

Dino Gerardi

No 12699, CEPR Discussion Papers from C.E.P.R. Discussion Papers

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.

Keywords: Dynamic contracting; Limited commitment; Ratchet effect (search for similar items in EconPapers)
JEL-codes: D80 D82 D86 (search for similar items in EconPapers)
Date: 2018-02
New Economics Papers: this item is included in nep-cta and nep-mic
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

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Working Paper: Dynamic Contracting with Limited Commitment and the Ratchet Effect (2015)
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