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Optimal incentive mix of performance pay and efficiency wage

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Author Info
Anders Frederiksen () (Aarhus School of Business, Center for Corporate Performance and IZA)
Elod Takats () (Princeton University, Economics Department)

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Abstract

Firms use a rich set of incentives including fixed wages, bonuses, threat of firing and promise of promotion. Yet, we do not have a theoretical understanding of how such a mix of incentives can arise. This paper aims to build a theoretical model which describes the incentive mix as the solution to an optimal contracting problem and provides broader testable implications. The basic model has a principal-agent relationship with unobservable effort. The integrative model includes the basic model and three building blocks: job-assignment, learning and human capital. The derived incentive mix is a consequence of the dual role of firing. It is both an incentive and a sorting decive. The model's predictions are tested on firm-level data from a large pharmaceutical company. The broader testable implications beyond the incentive mix are also confirmed by the data.

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Publisher Info
Paper provided by Institute of Economics, Hungarian Academy of Sciences in its series IEHAS Discussion Papers with number 0418.

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Length: 36 pages
Date of creation: Nov 2004
Date of revision:
Handle: RePEc:has:discpr:0418

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Baker, George P, 1992. "Incentive Contracts and Performance Measurement," Journal of Political Economy, University of Chicago Press, vol. 100(3), pages 598-614, June. [Downloadable!] (restricted)
  2. Shapiro, Carl & Stiglitz, Joseph E, 1984. "Equilibrium Unemployment as a Worker Discipline Device," American Economic Review, American Economic Association, vol. 74(3), pages 433-44, June. [Downloadable!] (restricted)
  3. Edward P. Lazear, 2000. "Performance Pay and Productivity," American Economic Review, American Economic Association, vol. 90(5), pages 1346-1361, December. [Downloadable!] (restricted)
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  4. W. Bentley MacLeod, 2003. "Optimal Contracting with Subjective Evaluation," American Economic Review, American Economic Association, vol. 93(1), pages 216-240, March. [Downloadable!] (restricted)
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  5. Medoff, James L & Abraham, Katharine G, 1980. "Experience, Performance, and Earnings," The Quarterly Journal of Economics, MIT Press, vol. 95(4), pages 703-36, December. [Downloadable!] (restricted)
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  6. MacLeod, W Bentley & Malcomson, James M, 1998. "Motivation and Markets," American Economic Review, American Economic Association, vol. 88(3), pages 388-411, June. [Downloadable!] (restricted)
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  7. Brian J. Hall & Kevin J. Murphy, 2003. "The Trouble with Stock Options," Journal of Economic Perspectives, American Economic Association, vol. 17(3), pages 49-70, Summer. [Downloadable!] (restricted)
  8. Brian J. Hall & Kevin J. Murphy, 2003. "The Trouble with Stock Options," NBER Working Papers 9784, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  9. Gibbons, Robert & Waldman, Michael, 1999. "Careers in organizations: Theory and evidence," Handbook of Labor Economics, in: O. Ashenfelter & D. Card (ed.), Handbook of Labor Economics, edition 1, volume 3, chapter 36, pages 2373-2437 Elsevier. [Downloadable!] (restricted)
  10. Lazear, Edward P, 1989. "Pay Equality and Industrial Politics," Journal of Political Economy, University of Chicago Press, vol. 97(3), pages 561-80, June. [Downloadable!] (restricted)
  11. MacLeod, W Bentley & Malcomson, James M, 1989. "Implicit Contracts, Incentive Compatibility, and Involuntary Unemployment," Econometrica, Econometric Society, vol. 57(2), pages 447-80, March. [Downloadable!] (restricted)
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  12. Robert Gibbons, 1997. "Incentives and Careers in Organizations," NBER Working Papers 5705, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  13. James A. Mirrlees, 1976. "The Optimal Structure of Incentives and Authority Within an Organization," Bell Journal of Economics, The RAND Corporation, vol. 7(1), pages 105-131, Spring. [Downloadable!] (restricted)
  14. Robert Gibbons & Michael Waldman, 1999. "A Theory Of Wage And Promotion Dynamics Inside Firms," The Quarterly Journal of Economics, MIT Press, vol. 114(4), pages 1321-1358, November. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Iván Major, 2006. "Why do (or do not) banks share customer information? A comparison of mature private credit markets and markets in transition," IEHAS Discussion Papers 0603, Institute of Economics, Hungarian Academy of Sciences, revised 24 Apr 2006. [Downloadable!]
  2. András Simonovits, 2006. "Social Security Reform in the US: Lessons from Hungary," IEHAS Discussion Papers 0602, Institute of Economics, Hungarian Academy of Sciences, revised 24 Apr 2006. [Downloadable!]
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