TY  - JOUR
AU  - Prat,Julien
AU  - Jovanovic,Boyan
TI  - Dynamic Incentive Contracts Under Parameter Uncertainty
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 16649
PY  - 2010
Y2  - December 2010
UR  - http://www.nber.org/papers/w16649
L1  - http://www.nber.org/papers/w16649.pdf
N1  - Author contact info:
Julien Prat
University of Vienna
Vienna, AUSTRIA
E-Mail: julien.prat@univie.ac.at

Boyan Jovanovic
New York University
Department of Economics
19 W. 4th Street, 6th Floor
New York, NY  10012
Tel: 212/998-8953
Fax: 212/995-4186
E-Mail: Boyan.Jovanovic@nyu.edu
AB  - We analyze a long-term contracting problem involving common uncertainty about a parameter capturing the productivity of the relationship, and featuring a hidden action for the agent. We develop an approach that works for any utility function when the parameter and noise are normally distributed and when the effort and noise affect output additively. We then analytically solve for the optimal contract when the agent has exponential utility. We find that the Pareto frontier shifts out as information about the agent's quality improves. In the standard spot-market setup, by contrast, when the parameter measures the agent's  'quality', the Pareto frontier shifts inwards with better information. 
Commitment is therefore more valuable when quality is known more precisely. Incentives then are easier to provide because the agent has less room to manipulate the beliefs of the principal. Moreover, in contrast to results under one-period commitment, wage volatility declines as experience accumulates.
ER  -