Rewarding improvements: optimal dynamic contracts with subjective evaluation

We study a T‐period contracting problem where performance evaluations are subjective and private. We find that the principal should punish the agent for performing poorly in the future even when the evaluations were good in the past; at the same time, the agent should be given opportunities to make up for poor evaluations in the past with better performance in the future. Optimal incentives are thus asymmetric. Conditional on the same number of good evaluations, an agent whose performance improves over time should be better rewarded than one whose performance deteriorates.