We model deferred compensation as a share of an uncertain future profit granted by a financially constrained employer to her employee in mutual agreement. Deferred compensation serves as a retention mechanism, helping the employer to avoid bankruptcy. The optimal combination of cash and deferred payments that a firm can use to retain qualified personnel depends on the cost of new credit and bank-ruptcy risk: If interest rates are greater (smaller) than the ex-ante odds of bankruptcy, the employer will to defer compensation (pay in cash) to the employee. The employee always improves his position in the labor market if imminent bankruptcy is avoided.
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Paper provided by Max Planck Institute of Economics, Strategic Interaction Group in its series Papers on Strategic Interaction with number
2004-24.
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