Working Paper: CEPR ID: DP9956
Authors: V. Bhaskar
Abstract: 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.
Keywords: Envelope theorem; First-order approach; Learning; Moral hazard; Ratchet effect
JEL Codes: D83; D86
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| shirking (J22) | perceived difficulty of the job (J29) |
| perceived difficulty of the job (J29) | continuation value of the agent (L85) |
| continuation value of the agent (L85) | incentives required to deter shirking (J33) |
| incentives required to deter shirking (J33) | overworking (J81) |
| ratchet effect (E32) | efficiency of incentive mechanisms (D61) |
| structure of the contract (L14) | agent's behavior (L85) |