Dynamic Correlation as an Incentive Device

TL;DR

This paper proposes dynamic correlation as an incentive mechanism in organizations, showing it improves effort incentives and communication structures, with implications for organizational communication and distributional conflicts.

Contribution

It introduces dynamic correlation as a novel incentive device that transitions communication from private to public, expanding the Pareto frontier in moral hazard settings.

Findings

Optimal mediation induces nonstationary correlated information structures.

Private communication correlation relaxes incentive constraints.

Mediation is Pareto-improving if the worker is sufficiently patient.

Abstract

I introduce dynamic correlation as an incentive instrument to address moral hazard. A firm mediates interactions between a long-lived worker and short-lived clients. I show that optimal mediation induces a nonstationary correlated information structure that transitions from private to public communication, consistent with the empirical shift from personalized to standardized communication in organizations. By using private communication to correlate continuations, the firm relaxes otherwise binding incentive constraints and strengthens effort incentives. Mediation expands the Pareto frontier and generates a distributional conflict between the worker and the average client, and is Pareto-improving if and only if the worker is sufficiently patient.