Management Practices

Abstract

This dissertation examines how firms manage the unfavorable impact of information asymmetry - be it not knowing payoff relevant characteristics of the employee or the inability to observe the actions taken by the employee. While firms develop a multitude of mechanisms to mitigate their impact, they aren't always able to completely eliminate them. The first essay studies the advantages and disadvantages of frequent performance reviews over intermittent performance reviews in situations where firms are unable to observe payoff relevant characteristics. Performance reviews are one of the tools used by firms to weed out ill-matched employees. How often they should be held has been the subject of a lot of debate recently. The key trade-off is the timing of information arrival and the amount of information. In frequent reviews managers learn about the employees sooner, but in intermittent reviews they have more information to go by. Each review regime performs better under different conditions. Thus, a priori frequent reviews do not always achieve better results than intermittent reviews. The second essay studies the problem of motivating effort when the employee has to plan and execute the project in the presence of limited liability. The employer is unable to observe the effort involved in information acquisition and the information itself giving rise to moral hazard. It is shown that limited liability induces a risk neutral agent to take excessive/insufficient risk for different parameter values. Thus, limited liability constraints not only raise the cost of contracting, they also change the level of risk taking. The third essay extends the model in the second essay to two periods. It is shown that the time of contracting affects the feasibility of the first-best solution.