DP8948 | Dynamic Moral Hazard, Learning and Belief Manipulation

Publication Date

01/04/2012

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Abstract

We study dynamic moral hazard, with symmetric ex ante uncertainty and learning. Unlike Holmstrom's career concerns model, uncertainty pertains to the difficulty of the job rather than the general talent of the agent, so that contracts are required to provide incentives. Since effort is privately chosen, the agent can always cause a misalignment of beliefs between the principal and himself, by shirking. We show that such a misalignment is always profitable for the agent, and must be dissuaded by providing more high powered incentives. However, high powered incentives in the future only aggravate the incentive problem today, so that the problem is compounded as the interaction becomes longer. We also study the benefits of long term contracts with full commitment, and the role of random effort choice.