We study a labour market in which firms can observe workers’ output but not their effort, and in which a worker’s productivity in a given firm depends on a worker-firm specific component, unobservable for the firm. Firms offer wage contracts that optimally trade off effort and wage costs. As a result, employed workers enjoy rents, which in turn create unemployment. We show that the incentive power of the equilibrium wage contract is constrained socially efficient in the absence of unemployment benefits. We then apply the model to explain the recent increase in performance-pay contracts. Within our model, this can be explained by three different factors: (i) increased importance of non-observable effort, (ii) a fall in the marginal tax rate, (iii) a reduction in the heterogeneity of workers performing the same task. The likely effect of all three factors is an increase in the equilibrium unemployment rate.
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Paper provided by Swedish Institute for Social Research in its series Working Paper Series with number
3/2003.
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.:
Oliver Hart & Bengt Holmstrom, 1986.
"The Theory of Contracts,"
Working papers
418, Massachusetts Institute of Technology (MIT), Department of Economics.
Acemoglu, Daron & Shimer, Robert, 1999.
"Holdups and Efficiency with Search Frictions,"
International Economic Review,
Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 40(4), pages 827-49, November.
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