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Adverse Selection and Pay Compression

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  • Jay Stewart

Abstract

A fundamental result of the principal-agent literature is that pay will be linked to performance when it is difficult for the principal to monitor the agent’s actions. However, performance pay can lead to adverse incentives. In these models, high-powered incentives encourage workers to neglect some aspects of their job or to sabotage their coworkers’ efforts. This paper offers another explanation for the weak link between pay and performance: worker heterogeneity. When workers are heterogeneous and labor contracts are contests, the Nash equilibrium often pools workers. I show that this implies that the link between pay and performance is weaker than would be the case if firms could observe workers’ types before contracting and offer each type their respective optimal contests.

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Bibliographic Info

Article provided by Southern Economic Association in its journal Southern Economic Journal.

Volume (Year): 65 (1999)
Issue (Month): 4 (April)
Pages: 885-899

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Handle: RePEc:sej:ancoec:v:65:4:y:1999:p:885-899

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Web page: http://www.southerneconomic.org/
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Cited by:
  1. Oxoby, Robert J., 2002. "Status characteristics, cognitive bias, and incentives in teams," Journal of Behavioral and Experimental Economics (formerly The Journal of Socio-Economics), Elsevier, vol. 31(3), pages 301-316.
  2. C. Stowe, 2009. "Incorporating morale into a classical agency model: implications for incentives, effort, and organization," Economics of Governance, Springer, vol. 10(2), pages 147-164, April.

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