“Interim Performance Evaluation in Contract Design” by Stephen Chiu
Bin R. Chen
Sun Yat-sen University
In this paper we study a principal-agent problem with two-stage complementary efforts, as well as limited liability on the agent's side. An interim-performance-evaluation (IPE) allows the principal to learn of the degree of success of the first stage investment. We .nd conditions under which such an IPE is profitable even if the continuation action plan is constant regardless of the IPE outcome. The conditions are related to the degree of task complementarity, which turns out to have a close relationship between the comparison of the likelihood ratios under different IPE outcomes. We also argue that notions such as morale and confidence, which are normally outside standard economic discourse, can be used to understand our results. This thus extends the line of studies on intrinsic motivation versus extrinsic incentive pioneered by Bénabou and Tirole (2003).