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Incentivizing Agents through Ratings

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  • Peiran Xiao

Abstract

I study the optimal design of ratings to motivate agent investment in quality when transfers are unavailable. The principal designs a rating scheme that maps the agent's quality to a (possibly stochastic) score. The agent has private information about his ability, which determines his cost of investment, and chooses the quality level. The market observes the score and offers a wage equal to the agent's expected quality. For example, a school incentivizes learning through a grading policy that discloses the student's quality to the job market. I reduce the principal's problem to the design of an interim wage function of quality. When restricted to deterministic ratings, I provide necessary and sufficient conditions for the optimality of simple pass/fail tests and lower censorship. In particular, when the principal's objective is expected quality, pass/fail tests are optimal if agents' abilities are concentrated towards the top of the distribution, while pass/lower censorship is optimal if abilities are concentrated towards the mode. The results generalize existing results in optimal delegation with voluntary participation, as pass/fail tests (lower censorship) correspond to take-it-or-leave-it offers (threshold delegation). Additionally, I provide sufficient conditions for deterministic ratings to remain optimal when stochastic ratings are allowed. For quality maximization, pass/fail tests remain optimal if the ability distribution becomes increasingly more concentrated towards the top.

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  • Peiran Xiao, 2024. "Incentivizing Agents through Ratings," Papers 2407.10525, arXiv.org, revised Nov 2024.
    • Handle: RePEc:arx:papers:2407.10525
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    References listed on IDEAS

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    1. Martin F. Hellwig, 2010. "Incentive Problems With Unidimensional Hidden Characteristics: A Unified Approach," Econometrica, Econometric Society, vol. 78(4), pages 1201-1237, July.
    2. S Nageeb Ali & Nima Haghpanah & Xiao Lin & Ron Siegel, 2022. "How to Sell Hard Information," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 137(1), pages 619-678.
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