The purpose of this paper is to examine the effects of workers not knowing their performance capability for job‐related skills on their contract selection decisions. We hypothesize that participants with incomplete personal capability knowledge will tend to be overconfident about their abilities and that such overconfidence will affect contract choice (they will incorrectly select a performance‐based contract when they should select a fixed‐pay contract) and result in lower participant earnings. We also hypothesize that once these participants learn their actual performance capability they will be more likely to switch contracts in a subsequent period than participants who know their performance capability at the time of initial contract selection. We design an experiment to test our predictions and find strong support. The paper also discusses implications of the findings, limitations of the study, and suggestions for future research.
