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The Ratchet Effect and the Coordination of Production in the Absence of Rent Extraction

Pamela Clark Brown, Jeffrey B. Miller and James R. Thornton
Economica
New Series, Vol. 61, No. 241 (Feb., 1994), pp. 93-114
DOI: 10.2307/2555051
Stable URL: http://www.jstor.org/stable/2555051
Page Count: 22
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The Ratchet Effect and the Coordination of Production in the Absence of Rent Extraction
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Abstract

The ratchet is used frequently in incentive schemes even though the resulting ratchet effect is costly. Using a two-period, two-type, principal-agent model where the information asymmetry does not cause adverse selection or moral hazard, we show that, when coordination costs and the discount factor are high, the information gained through the ratchet effect is sufficiently valuable to offset the cost. These net gains may help explain why the ratchet has been observed in situations as diverse as managerial reward systems in the Soviet Union and salesman bonus arrangements in capitalist countries.

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