Abstract: In 2015, the government-imposed pay curbs in state-owned enterprises (SOEs) came into force, involving the principals of central enterprises down to the SOEs at different levels. Even though reducing the remuneration using a "one-size-fits-all" approach can save the cost of executives'salaries apparently, it can't compensate for the loss caused by managers' negative attitude toward work. Cost control has the potential which leads to the use of incentive schemes under asymmetric information. As time goes by, the principal (headquarters of SOEs) will take the agent's performance of cost control into consideration when modifying the scheme, which induces agent to be slack to avoid more demanding schedules in the future-the ratchet effect. The principal has to pay high rent to induce the agent to reveal its real type to weaken effect. However, the pay curbs may prevent it. A two-period game model is built and turns the equilibrium game model between the headquarters and production unit is turned into a perfect Bayesian equilibrium. As the starting point, the effect about incomplete information on effort in a static framework is researched. In the beginning, there are some given assumptions, such as impossible to promise the intertemporal incentive scheme, sequential selection of the rewarding programme and realizing cost, the incentive scheme revised dynamically. Research results show that the managers of high-efficiency production unit can always imitate the low-efficiency ones in low cost. When the probability distribution is poor, the agent has the incentive to persuade the principal that they are low efficiency. More importantly, the incentive scheme, which can achieve the separating equilibrium, is better in order to maximize utility. And there is trade-off between information rent and effort level in the optimal value. Under quasi-separating equilibrium or pool equilibrium, there exists stronger incentives than in static model due to ratchet effect. In summary, the paper explores the ratchet effect caused by asymmetric information as well as the balance between the incentives of optimal contract and rent extraction. Under given conditions, the separating equilibrium can strike an average between information rent and effort efficiency, weaken the ratchet effect and optimize the utility of headquarters of SOEs. The study and its conclusion provide theoretical direction for the formulation and implement of government-imposed pay curbs.

Key words: cost control, ratchet effect, separating equilibrium