Feedback Design in Dynamic Moral Hazard

Jeffrey Ely, George Georgiadis and Luis Rayo

No 18283, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: We study the joint design of dynamic incentives and performance feedback for an environment with a coarse (all-or-nothing) measure of performance. Using a novel approach to incentive compatibility, we derive a two-phase solution that begins with a “silent phase†where the agent is given no feedback and is asked to work nonstop, and ends with a †full-transparency phase†where the agent stops working as soon as a performance threshold is met. Hiding information leads to greater effort but comes at a cost because an ignorant agent is more expensive to motivate. The two-phase solution—where the agent’s ignorance is fully frontloaded—stems from a “backward compounding effect†that raises the cost of hiding information as time passes. Whenever the agent’s hazard rate of success falls sufficiently over time, the principal should eventually give up on them, as occurs in practice with up-or-out promotion policies.

Date: 2023-07
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