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Market-based incentives

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  • Grochulski, Borys
  • Zhang, Yuzhe

Abstract

We study optimal incentives in a principal-agent problem in which the agent's outside option is determined endogenously in a competitive labor market. In equilibrium, strong performance increases the agent's market value. When this value becomes sufficiently high, the threat of the agent's quitting forces the principal to give the agent a raise. The prospect of obtaining this raise gives the agent an incentive to exert effort, which reduces the need for standard incentives, like bonuses. In fact, whenever the agent's option to quit is close to being ``in the money,'' the market-induced incentive completely eliminates the need for standard incentives.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 45576.

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Date of creation: 25 Mar 2013
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Handle: RePEc:pra:mprapa:45576

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Keywords: Market-based incentive; Career Concerns; Endogenous outside option; Limited commitment; Private information; Wage contract;

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  1. Krueger, Dirk & Uhlig, Harald, 2006. "Competitive risk sharing contracts with one-sided commitment," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1661-1691, October.
  2. Grochulski, Borys & Zhang, Yuzhe, 2011. "Optimal risk sharing and borrowing constraints in a continuous-time model with limited commitment," Journal of Economic Theory, Elsevier, vol. 146(6), pages 2356-2388.
  3. Andrew Atkeson & Robert E Lucas, 2010. "On Efficient Distribution with Private Information," Levine's Working Paper Archive 2179, David K. Levine.
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  14. Edward P. Lazear, 1996. "Performance Pay and Productivity," NBER Working Papers 5672, National Bureau of Economic Research, Inc.
  15. Thomas, Jonathan & Worrall, Tim, 1988. "Self-enforcing Wage Contracts," Review of Economic Studies, Wiley Blackwell, vol. 55(4), pages 541-54, October.
  16. Spear, Stephen E & Srivastava, Sanjay, 1987. "On Repeated Moral Hazard with Discounting," Review of Economic Studies, Wiley Blackwell, vol. 54(4), pages 599-617, October.
  17. Bengt Holmstrom, 1980. "Equilibrium Long-Term Labor Contracts," Discussion Papers 414R, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
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