The Ratchet Effect: A Learning Perspective

We examine the ratchet effect under moral hazard and symmetric learning by worker and firm about new technology. Shirking increases the worker’s future payoffs, since the firm overestimates job difficulty. High-powered incentives to deter shirking induce the agent to over-work, since he can quit if the firm thinks the job is too easy. With continuous effort choices, no deterministic interior effort is implementable. We provide conditions under which randomized effort is implementable, so that a profit-maximizing distribution over efforts exists