The Extrinsic Motivation of Freedom at Work∗

Why does a worker become more efficient when given freedom at work? Under incomplete contracts, a worker faces a ratchet effect of innovating when he is closely monitored: if the worker uncovers a more efficient production method, the firm, being aware of it, raises the future performance requirement; anticipating this, the worker never tries to innovate. When given freedom at work instead, the worker accrues private information about his innovation. The resulting information asymmetry generates information rent which feeds back as the worker’s incentive to innovate and improve efficiency. This paper studies how a firm’s strategic ignorance influences its incentive structure which has to simultaneously induce effort from the worker and endogenously generate asymmetric information against the firm. The resulting mechanism provides a novel rationale to why relationships are sometimes characterized by weak incentives and low-scale production at the early stages. ∗I am grateful to Navin Kartik and W. Bentley MacLeod for their generous support on this paper. I have also benefited immensely from discussions with Yeon-Koo Che and Anh Nguyen. I also thank Charles Angelucci, Douglas Bernheim, Pierre-André Chiappori, Julien Combe, Marina Halac, Suehyun Kwon, Andrea Prat, Canice Prendergast, Daniel Rappoport, Mike Riordan, Bernard Salanié, Juuso Toikka, Joel Watson, Enrico Zanardo, and seminar participants at Columbia University, National University of Singapore and UC San Diego for very helpful comments and suggestions. †[email protected]. Department of Economics, Columbia University.