How can a principal (employer or voter) induce an agent (worker or politician) to choose the "right" actions if risky actions reveal the agent's decision-making competence and only dismissal can be used as an incentive instrument? We first show that if the principal can commit to a replacement strategy, then optimal mechanisms involve either (i) a probationary period and then indefinite tenure, or (ii) dismissing poorly performing agents but also randomly replacing agents who take nonrevealing actions. When the principal cannot commit, incentives can be improved by imposing term limits on agents. (JEL D72, D82, M51).

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1 August 2016

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American Economic Journal: Microeconomics 8(3) , pp.1-38, 2016

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DOI: 10.1257/mic.20150083

https://www.aeaweb.org/articles?id=10.1257/mic.20150083

This Journal article is published under the centre's Growth programme.