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The "Ratchet Principle" and Performance Incentives
Martin L. Weitzman
The Bell Journal of Economics
Vol. 11, No. 1 (Spring, 1980), pp. 302-308
Published by: RAND Corporation
Stable URL: http://www.jstor.org/stable/3003414
Page Count: 7
You can always find the topics here!Topics: Corporations, Historically informed performance, Ratchet effect, Economic models, Prices, Random variables, Optimal solutions, Optimal policy, Incentive plans, Incentive principles
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The use of current performance as a partial basis for setting future targets is an almost universal feature of economic planning. This "ratchet principle," as it is sometimes called, creates a dynamic incentive problem for the enterprise. Higher rewards from better current performance must be weighed against the future assignment of more ambitious targets. In this paper I formulate the problem of the enterprise as a multiperiod stochastic optimization model incorporating an explicit feedback mechanism for target setting. I show that an optimal solution is easily characterized, and that the incentive effects of the ratchet principle can be fully analyzed in simple economic terms.
The Bell Journal of Economics © 1980 RAND Corporation