Unobservable Persistant Productivity and Long Term Contracts

Hugo Hopenhayn and Arantxa Jarque

UC3M Working papers. Economics from Universidad Carlos III de Madrid. Departamento de Economía

Abstract: We study the problem of a firm that faces asymmetric information about the productivity of its potential workers. In our framework, a worker’s productivity is either assigned by nature at birth, or determined by an unobservable initial action of the worker that has persistent effects over time. We provide a characterization of the optimal dynamic compensation scheme that attracts only high productivity workers: consumption –regardless of time period– is ranked according to likelihood ratios of output histories, and the inverse of the marginal utility of consumption satisfies the martingale property derived in Rogerson (1985). However, in the case of i.i.d. output and square root utility we show that, contrary to the features of the optimal contract for a repeated moral hazard problem, the level and the variance of consumption are negatively correlated, due to the influence of early luck into future compensation. Moreover, in this example long-term inequality is lower under persistent private information

Keywords: Mechanism; design; Moral; hazard; Persistence (search for similar items in EconPapers)
JEL-codes: D80 D82 (search for similar items in EconPapers)
Date: 2009-03
New Economics Papers: this item is included in nep-bec and nep-cta
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Journal Article: Unobservable Persistent Productivity and Long Term Contracts (2010)
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Persistent link: https://EconPapers.repec.org/RePEc:cte:werepe:we092717

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