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Occupational choice, incentives and wealth distribution

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  • Archishman Chakraborty
  • Alessandro Citanna

Abstract

We consider a model of endogenous occupational choice in economies with a continuum of individuals who differ in their wealth endowments. Individuals have a choice of remaining self-employed or engaging in productive matches with other individuals, i.e., forming ``firms''. Such matches are subject to a hidden-action moral hazard problem with a limited liability constraint. This leads to wealth effects and the payoff-relvance of wealth differences across individuals. We suppose that the division of the gains from such matches is endogenous and determined by competitive market forces but that contracts are chosen optimally within matches subject to the market determined division of the gains from matching. We show, in contrast to previous results in the literature, that even when financial markets are perfect, the equilibrium distributions of occupations, utilities and surplus depend on the distribution of wealth in the economy. When financial markets are imperfect however, the equilibrium might involve the economy ``segregating'' into a high-surplus rich sector and a low-surplus poor sector, independent of the distribution of wealth in the economy. We also characterize the nature of the equilibrium as a function of financial market imperfections and also as a function of the nature (symmetry) of the underlying agency problem within a firm.

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Paper provided by Carnegie Mellon University, Tepper School of Business in its series GSIA Working Papers with number 225.

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Handle: RePEc:cmu:gsiawp:225

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Postal: Tepper School of Business, Carnegie Mellon University, 5000 Forbes Avenue, Pittsburgh, PA 15213-3890
Web page: http://www.tepper.cmu.edu/

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  1. Edward Simpson Prescott & Robert M. Townsend, 2006. "Firms as Clubs in Walrasian Markets with Private Information," Journal of Political Economy, University of Chicago Press, vol. 114(4), pages 644-671, August.
  2. Rogerson, William P, 1985. "The First-Order Approach to Principal-Agent Problems," Econometrica, Econometric Society, vol. 53(6), pages 1357-67, November.
  3. Gary S. Becker, 1974. "A Theory of Marriage: Part II," NBER Chapters, in: Marriage, Family, Human Capital, and Fertility, pages 11-26 National Bureau of Economic Research, Inc.
  4. Michael Kremer & Eric Maskin, 1996. "Wage Inequality and Segregation by Skill," NBER Working Papers 5718, National Bureau of Economic Research, Inc.
  5. Harold L Cole & Edward C Prescott, 1997. "Valuation equilibrium with Clubs," Levine's Working Paper Archive 912, David K. Levine.
  6. Richard E. Kihlstrom & Jean-Jacques Laffont, . "A Competitive Entrepreneurial Model of a Stock Market," Rodney L. White Center for Financial Research Working Papers 02-80, Wharton School Rodney L. White Center for Financial Research.
  7. Bryan Ellickson & Birgit Grodal & Suzanne Scotchmer & William R. Zame, 1999. "Clubs and the Market," Econometrica, Econometric Society, vol. 67(5), pages 1185-1218, September.
  8. Michael Kremer & Eric Maskin, 1996. "Wage Inequality and Segregation," Harvard Institute of Economic Research Working Papers 1777, Harvard - Institute of Economic Research.
  9. Kaneko, Mamoru & Wooders, Myrna Holtz, 1986. "The core of a game with a continuum of players and finite coalitions: The model and some results," Mathematical Social Sciences, Elsevier, vol. 12(2), pages 105-137, October.
  10. Milgrom, P. & Shannon, C., 1991. "Monotone Comparative Statics," Papers 11, Stanford - Institute for Thoretical Economics.
  11. Legros, Patrick & Newman, Andrew F., 1996. "Wealth Effects, Distribution, and the Theory of Organization," Journal of Economic Theory, Elsevier, vol. 70(2), pages 312-341, August.
  12. Patrick Legros & Andrew F. Newman, 2002. "Monotone Matching in Perfect and Imperfect Worlds," Review of Economic Studies, Oxford University Press, vol. 69(4), pages 925-942.
  13. Banerjee, Abhijit V & Newman, Andrew F, 1993. "Occupational Choice and the Process of Development," Journal of Political Economy, University of Chicago Press, vol. 101(2), pages 274-98, April.
  14. Becker, Gary S, 1973. "A Theory of Marriage: Part I," Journal of Political Economy, University of Chicago Press, vol. 81(4), pages 813-46, July-Aug..
  15. Helpman, Elhanan & Laffont, Jean-Jacques, 1975. "On moral hazard in general equilibrium theory," Journal of Economic Theory, Elsevier, vol. 10(1), pages 8-23, February.
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Cited by:
  1. Maitreesh Ghatak & Alexander Karaivanov, 2011. "Contractual Structure and Endogenous Matching in Partnershipso," STICERD - Economic Organisation and Public Policy Discussion Papers Series 024, Suntory and Toyota International Centres for Economics and Related Disciplines, LSE.
  2. Mette Ejrnæs & Stefan Hochguertel, 2008. "Entrepreneurial Moral Hazard in Income Insurance: Empirical Evidence from a Large Administrative Sample," CAM Working Papers 2008-02, University of Copenhagen. Department of Economics. Centre for Applied Microeconometrics.

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