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High Compensation Creates a Ratchet Effect

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Author Info
Gersbach, Hans () (University of Heidelberg, CEPR and IZA Bonn)
Glazer, Amihai (University of California, Irvine)

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Abstract

We consider a firm which pays a worker for his effort over several periods. The more the firm pays in one period, the wealthier the worker is in the following periods, and so the more he must be paid for a given effort. This wealth effect can induce an employer to pay little initially and more later on. For related reasons, the worker may work harder than the employer prefers. The incentive contracts firms offer may therefore cap the worker’s earnings. Lastly, this wealth ratchet effect can induce excessive firing and turnover.

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Publisher Info
Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 1143.

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Length: 28 pages
Date of creation: May 2004
Date of revision:
Handle: RePEc:iza:izadps:dp1143

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Related research
Keywords: principal-agent compensation moral hazard wealth effects Ratchet effects high-powered incentives

Find related papers by JEL classification:
D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
J30 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - General
J60 - Labor and Demographic Economics - - Mobility, Unemployment, and Vacancies - - - General

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References listed on IDEAS
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    Other versions:
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  6. Gibbons, Robert & Murphy, Kevin J, 1992. "Optimal Incentive Contracts in the Presence of Career Concerns: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 100(3), pages 468-505, June. [Downloadable!] (restricted)
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  7. Judith K. Hellerstein & David Neumark & Kenneth R. Troske, 1996. "Wages, Productivity, and Worker Characteristics: Evidence from Plant-Level Production Functions and Wage Equations," NBER Working Papers 5626, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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