Self-selection and Monitoring in Dynamic Incentive Problems with Incomplete Contracts.

A dynamic trading problem is examined in which a monopsonistic employer hires workers with private information. The employer chooses between two mutually exclusive outcomes. In the mar ket outcome, the employer offers long-term contracts and information is conveyed entirely through self-selection and delayed production. In the monitoring outcome, the employer offers short-term contracts and contract renegotiation is conditioned by an employee's past performance. A simple characterization theorem is provided that illustrates surprising effects of improvements in information. For example, an employer who is initially offering short-term contracts may stop monitoring and shift to market screening when the monitoring technology becomes more informative. Copyright 1993 by The Review of Economic Studies Limited.