Reciprocity in Dynamic Employment Relationships

Matthias Fahn (JKU Linz)

Abstract : This paper explores how a relational contract establishes a norm of reciprocity and how such a norm shapes the provision of informal incentives. Developing a model of a long-term employment relationship, I show that generous upfront wages that activate the norm of reciprocity are more important when an employee is close to retirement. In earlier stages, direct incentives promising a bonus in exchange for effort are more effective. Then, a longer remaining time horizon increases the employer’s commitment. Generally, direct and reciprocity-based incentives reinforce each other and should thus optimally be used in combination. I also show that more competition can magnify the use of reciprocity-based incentives. Moreover, with asymmetric information on the employee’s responsiveness to the norm of reciprocity, an early separation of types is generally optimal. Then, the principal might benefit from asymmetric information because a firing threat is only credible if the employee potentially is not reciprocal.

Optimal Incentives Under Moral Hazard: from Theory to Practice

George Georgiadis (Northwestern University)
Michael Powell (Northwestern University)

Abstract : This paper addresses the following practical question: given an existing incentive contract, what information must a manager acquire to determine how to improve upon that contract? We use a canonical principal-agent framework under moral hazard and assume the principal has productivity data corresponding to some status quo contract. Our main result shows that if the principal has a priori information about the agent’s marginal utility function, and she carries out an experiment in which she perturbs the existing contract, then she can estimate how the agent will respond to a change in his marginal incentives, as well as how the agent’s marginal incentives will respond to any other perturbed contract. The information provided by such an experiment, therefore, serves as a sufficient statistic for the question of how to locally improve upon the existing contract optimally. The same informational requirements hold, and an analogous sufficient statistic result is obtained, when the principal is restricted to choosing from a lower-dimensional parametric class of contracts; e.g., linear contracts. We also describe the informational requirements for assessing global optimality, where local information like the type described above is insufficient.

Aspiration, Inspiration and Perspiration: a Model of Dynamic Project Choice

Johannes Schneider (Carlos 3 Madrid)
Christoph Wolf (Bocconi U)

Abstract : Progress results either from diligent, time-consuming work or from creative inspiration. Consider an agent looking for a solution to a problem while facing a deadline. The agent dynamically decides whether to look on the diligent road or on the creative road. Progress arrives stochastically and the diligent road leads to a solution eventually. The creative road is quicker, but sometimes infeasible. Looking on the creative road provides information about its feasibility. Optimal choices are non-monotone. The agent focuses on creative work if the deadline is soon or far. He concentrates on diligent work for intermediate time remaining. A principal who cares about both screening and output offers one of two contracts: (i) A short deadline and tenure for creative solutions, or (ii) instant tenure and promotion for all creative and some diligent solutions. Our applications are academic careers, election cycles and policy reforms, and product innovation.