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On the Efficiency of the Rank-Order Contract under Moral Hazard and Adverse Selection

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  • Yun, Jungyoll

Abstract

This article analyzes the efficiency of the rank-order contract for a finite number of risk-neutral agents under both moral hazard and adverse selection. The first-best outcome is shown to be supported by a set of rank-order contracts which penalize a small fraction of agents but do so heavily. The article also shows how these rank-order contracts compare with those giving a large prize to few agents. Finally, the article provides an informal argument for why firms do not follow a penalty-giving rank-order contract in their promotion policies as often as the theory predicts. Copyright 1997 by University of Chicago Press.

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  • Yun, Jungyoll, 1997. "On the Efficiency of the Rank-Order Contract under Moral Hazard and Adverse Selection," Journal of Labor Economics, University of Chicago Press, vol. 15(3), pages 466-494, July.
    • Handle: RePEc:ucp:jlabec:v:15:y:1997:i:3:p:466-94
    DOI: 10.1086/209868
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    References listed on IDEAS

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    1. Lazear, Edward P & Rosen, Sherwin, 1981. "Rank-Order Tournaments as Optimum Labor Contracts," Journal of Political Economy, University of Chicago Press, vol. 89(5), pages 841-864, October.
    2. Green, Jerry R & Stokey, Nancy L, 1983. "A Comparison of Tournaments and Contracts," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 349-364, June.
    3. Barry Nalebuff & David Scharfstein, 1987. "Testing in Models of Asymmetric Information," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 54(2), pages 265-277.
    4. Rosen, Sherwin, 1986. "Prizes and Incentives in Elimination Tournaments," American Economic Review, American Economic Association, vol. 76(4), pages 701-715, September.
    5. Bhattacharya, Sudipto & Guasch, J Luis, 1988. "Heterogeneity, Tournaments, and Hierarchies," Journal of Political Economy, University of Chicago Press, vol. 96(4), pages 867-881, August.
    6. George Baker & Michael Gibbs & Bengt Holmstrom, 1994. "The Internal Economics of the Firm: Evidence from Personnel Data," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 109(4), pages 881-919.
    7. Malcomson, James M, 1984. "Work Incentives, Hierarchy, and Internal Labor Markets," Journal of Political Economy, University of Chicago Press, vol. 92(3), pages 486-507, June.
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    Cited by:

    1. Ghazala Azmat & Marc Möller, 2012. "The Distribution of Talent across Contests," Working Papers 600, Barcelona School of Economics.
    2. Christian Riis, 2010. "Efficient Contests," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 19(3), pages 643-665, September.
    3. Ghazala Azmat & Marc Möller, 2018. "The Distribution of Talent Across Contests," Economic Journal, Royal Economic Society, vol. 128(609), pages 471-509, March.
    4. Riis, Christian, 2008. "Efficient Contests," MPRA Paper 10906, University Library of Munich, Germany.
    5. Theofanis Tsoulouhas, 2017. "Do tournaments solve the adverse selection problem?," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 26(3), pages 675-690, September.

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