Multistage Contracting with Applications to R&D and Insurance Policies

An agent undertakes a nonobservable first‐stage effort. The principal observes whether the effort results in a successful project or not. If the project succeeds, only the firm observes its interim quality, and can further improve it with a nonobservable second‐stage effort. If the agent accepts penalties when the first‐stage fails, moral hazard and asymmetric information do not prevent the principal from implementing her first‐best outcome. However, if the agent is bounded by the maximum loss he can bear when the first‐stage fails (limited liability), the principal induces the agent to exert a first‐stage effort below the first‐best level and a second‐stage effort above the first‐best level when the interim quality of his project is low. This distortion in efforts implies that the ex post rent left to the agent with a project of high interim quality is above the first‐best level. This provides a rationale for the optimality of expanding the use of the “carrot” (second‐stage rent) when the use of the “stick” (first‐stage penalty) is restricted. Implications of the theory for R&D, bank, job, and insurance contracts are discussed.     

Career Paths,Unemployment, and the Efficiency of the Labor Market: Should Youth Employment Be Subsidized?

This paper studies the implications of learning‐by‐doing on youth unemployment and market efficiency when workers benefiting from this kind of training experience search (while on the job) for a higher skill job. Firms with low‐skill jobs suffer from a poaching behavior by firms with high‐skill jobs, causing a shortage of low‐skill jobs and excessive youth unemployment. An optimal policy, consisting of taxing the output of high‐skill jobs and subsidizing the output of low‐skill jobs, restores market efficiency and reduces youth unemployment.