A theory of dynamic investment in education in response to accountability pressure

•I propose a dynamic investment model of schools in an environment with accountability.•Scores continually degrade as costly investments are made to coincide with sanctions.•Simulations show that blindly setting thresholds or rewards leads to lower scores.•RD analysis with data from NC, which had a merit-pay system, corroborates the model.

While well-implemented accountability systems are effective in inducing sharp test scores gains after intervention, it remains a mystery why such schools with the technical capacity to improve would allow productivity to decline to the point of sanction in the first place. We present a theory of dynamic investment where schools look forward and rationally choose the timing of reforms to increase achievement at the point of sanctions. Theory shows that policy makers must select the strength of sanctions carefully to maximize education production. Regression discontinuity analysis of a merit-pay system in North Carolina corroborates the theory.