"The Affect of the Learning Curve on the Optimal Dynamic Contract" (2008)

Undergraduate: Robert Butters

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An increase in the marginal productivity of laborers due to the existence of a learning curve illustrates a potential dynamic that should affect the structure of the employer-employee contract. This paper investigates the role of moral hazard in a dynamic setting given the presence of a learning curve and how this influences the shape of the optimal contract offered by the principal. By extending the standard principal agent problem to both a multi-action space for the agent and a dynamic setting, the analysis of the learning curve becomes tractable. The typical issues raised in the standard principal-agent problem including; the role of unverifiable information, the role of risk averseness, sufficient conditions for the use of first order conditions, and the role of the cost functions of each action form the basis of the analysis.