Informative Milestones in Experimentation

Abstract

I study the optimal contract offered by a principal funding a financially constrained agent to work on a multistage project. The project requires all stages to be completed to realize its benefits. Exerting effort in early stages of the project is informative but not conclusive about the prospects of future stages. The optimal contract features milestones that have to be achieved before a deadline. If the project is ultimately successful, the agent is rewarded with a share of the benefits that depends on performance in earlier stages. The timing of successes in early stages influences the belief of the players in later stages and thereby the deadlines and shares. Later successes imply more pessimism about the project's quality. Surprisingly, the effect of learning does not necessarily induce deadlines and shares to be monotone in the success time. The prospects of the project become worse which decreases the deadline and share initially. As the prospects worsen further, it becomes harder for the principal to incentivize the agent to exert effort. In this case, the agent has to be rewarded with additional rents that are provided through extended deadlines and increased shares. 1