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Compensation Methods in a Competitive Labor Market: the Role of Asymmetric Information

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Author Info
Felipe Balmaceda ()

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Abstract

In this paper we develop an asymmetric information model that provides a rationale for the existence of pay-for-performance contracts in the absence of incentive for effort and explains when and in which occupations pay-for-performance is more likely to be observed. In our model competition among firms for the best workers forces firm to link pay to performance in order to provide the best workers with a higher expected compensation. Furthermore, the model predicts among other things and contrary to the moral hazard model, that there is an equilibrium in which workers under contracts with a larger pay-for-performance sensitivity exert less effort than workers under contracts with a smaller pay-for-performance sensitivity. The paper also makes contributions to the theoretical literature on screening games. It is shown that in a competitive market and under a slightly modified timing than the one proposed by Rothschild and Stiglitz’ (1976) a unique equilibrium exits when a appropriately chosen equilibrium refinement is used and that the standard result in screening games in monopolistic settings known as no distortion at the top (see, Laffont and Tirole, 1996) does not hold in a competitive market.

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Paper provided by Centro de Economía Aplicada, Universidad de Chile in its series Documentos de Trabajo with number 139.

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Date of creation: 2002
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Handle: RePEc:edj:ceauch:139

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  1. Baker, George & Gibbs, Michael & Holmstrom, Bengt, 1994. "The Wage Policy of a Firm," The Quarterly Journal of Economics, MIT Press, vol. 109(4), pages 921-55, November. [Downloadable!] (restricted)
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  3. Kevin J. Murphy, 1986. "Incentives, Learning, and Compensation: A Theoretical and Empirical Investigation of Managerial Labor Contracts," RAND Journal of Economics, The RAND Corporation, vol. 17(1), pages 59-76, Spring. [Downloadable!] (restricted)
  4. Mailath George J. & Okuno-Fujiwara Masahiro & Postlewaite Andrew, 1993. "Belief-Based Refinements in Signalling Games," Journal of Economic Theory, Elsevier, vol. 60(2), pages 241-276, August. [Downloadable!] (restricted)
  5. Gibbs, Michael, 1995. "Incentive compensation in a corporate hierarchy," Journal of Accounting and Economics, Elsevier, vol. 19(2-3), pages 247-277, April. [Downloadable!] (restricted)
  6. Mark Rosenzweig & Andrew D. Foster, . "Comparative Advantage, Information and the Allocation of Workers to Tasks: Evidence from an Agricultural Labor Market," Home Pages _066, University of Pennsylvania. [Downloadable!]
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  7. Murphy, Kevin J., 1985. "Corporate performance and managerial remuneration : An empirical analysis," Journal of Accounting and Economics, Elsevier, vol. 7(1-3), pages 11-42, April. [Downloadable!] (restricted)
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  11. Rothschild, Michael & Stiglitz, Joseph E, 1976. "Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information," The Quarterly Journal of Economics, MIT Press, vol. 90(4), pages 630-49, November.
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    Other versions:
  13. Charles Brown, 1992. "Wage Levels and Method of Pay," RAND Journal of Economics, The RAND Corporation, vol. 23(3), pages 366-375, Autumn. [Downloadable!] (restricted)
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  14. Robert Gibbons & Kevin Murphy, 1989. "Relative Performance Evaluation for Chief Executive Officers," Working Papers 628, Princeton University, Department of Economics, Industrial Relations Section.. [Downloadable!]
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  15. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June. [Downloadable!] (restricted)
  16. Cho, In-Koo & Kreps, David M, 1987. "Signaling Games and Stable Equilibria," The Quarterly Journal of Economics, MIT Press, vol. 102(2), pages 179-221, May. [Downloadable!] (restricted)
  17. Stiglitz, Joseph E, 1987. "The Causes and Consequences of the Dependence of Quality on Price," Journal of Economic Literature, American Economic Association, vol. 25(1), pages 1-48, March. [Downloadable!] (restricted)
  18. Francine Lafontaine, 1992. "Agency Theory and Franchising: Some Empirical Results," RAND Journal of Economics, The RAND Corporation, vol. 23(2), pages 263-283, Summer. [Downloadable!] (restricted)
  19. Biglaiser Gary & Mezzetti Claudio, 1993. "Principals Competing for an Agent in the Presence of Adverse Selection and Moral Hazard," Journal of Economic Theory, Elsevier, vol. 61(2), pages 302-330, December. [Downloadable!] (restricted)
  20. Laffont, Jean-Jacques & Tirole, Jean, 1990. "Adverse Selection and Renegotiation in Procurement," Review of Economic Studies, Blackwell Publishing, vol. 57(4), pages 597-625, October. [Downloadable!] (restricted)
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  21. Canice Prendergast, 1999. "The Provision of Incentives in Firms," Journal of Economic Literature, American Economic Association, vol. 37(1), pages 7-63, March. [Downloadable!] (restricted)
  22. Baker, George & Gibbs, Michael & Holmstrom, Bengt, 1994. "The Internal Economics of the Firm: Evidence from Personnel Data," The Quarterly Journal of Economics, MIT Press, vol. 109(4), pages 881-919, November. [Downloadable!] (restricted)
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  24. Booth, A-L & Frank, J, 1997. "Performance Related Pay," CEPR Discussion Papers 364, Centre for Economic Policy Research, Research School of Social Sciences, Australian National University.
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  25. Charles Brown, 1990. "Firms' Choice of Method of Pay," NBER Working Papers 3065, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  26. Jensen, Michael C & Murphy, Kevin J, 1990. "Performance Pay and Top-Management Incentives," Journal of Political Economy, University of Chicago Press, vol. 98(2), pages 225-64, April. [Downloadable!] (restricted)
    Other versions:
  27. W. Bentley MacLeod & Daniel Parent, 1998. "Job Characteristics and the Form of Compensation," CIRANO Working Papers 98s-08, CIRANO. [Downloadable!]
  28. Petersen, Trond, 1991. "Reward Systems and the Distribution of Wages," Journal of Law, Economics and Organization, Oxford University Press, vol. 7(0), pages 130-58, Special I.
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  30. Bester, Helmut, 1985. "Screening vs. Rationing in Credit Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 75(4), pages 850-55, September. [Downloadable!] (restricted)
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  32. Canice Prendergast, 1996. "What Happens Within Firms? A Survey of Empirical Evidence on Compensation Policies," NBER Working Papers 5802, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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