Dynamic Reward Design

TL;DR

This paper analyzes a dynamic screening model with limited liability, revealing that optimal mechanisms involve backloading payments and incentivize consecutive work periods, with conditions affecting starting flexibility.

Contribution

It characterizes conditions under which the optimal dynamic mechanism either allows flexible starting periods or restricts to the first period, promoting consecutive work incentives.

Findings

Optimal mechanisms involve backloading payments.

Agents are incentivized to work consecutively once started.

Starting period flexibility depends on specific conditions.

Abstract

This paper studies a dynamic screening model in which a principal hires an agent with limited liability. The agent's private cost of working is an i.i.d. draw from a continuous distribution. His working status is publicly observable. The limited liability constraint requires that payments remain nonnegative at all times. In this setting, despite costs being i.i.d. and the payoffs being additively separable across periods, the optimal mechanism does not treat each period independently. Instead, it features backloading payments and requires the agent to work in consecutive periods. Specifically, I characterize conditions under which the optimal mechanism either grants the agent flexibility to start working in any period or restricts the starting period to the first. In either case, once the agent begins working, he is incentivized to work consecutively until the end.