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Effort Incentives and On-the-Job Search: An Alternative Role for Efficiency Wages in Employment Contracts

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  • Herbold, Daniel
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    Abstract

    We study an infinitely repeated principal-agent relationship with on-the-job search. On-the-job search is modeled as a dimension of the agent's effort vector that has no effect on output, but raises his future outside option. The agent's incentives to search are increasing in the degree to which a higher outside option improves his gains from trade. Search also increases the agent's cost of effort thus generating an effort-substitution problem between work and search effort. We show that the principal can mute search incentives by offering an e fficiency wage contract. Due to effort substitution, e fficiency wages increase the agent's work effort incentives for a given bonus scheme. Thus, effi ciency wages serve as a complement rather than as a substitute to piece rates. Our results provide a new rationale for the use of effi ciency wages as an incentive device and hence greatly extend the set of environments in which e fficiency wages are predicted to be useful as an incentive device. Our findings thus also contribute to the explanation of empirically observed inter-industry variation in the size and composition of worker compensation. --

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    Paper provided by Verein für Socialpolitik / German Economic Association in its series Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order with number 79983.

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    Date of creation: 2013
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    Handle: RePEc:zbw:vfsc13:79983

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    1. Lawrence F. Katz, 1986. "Layoffs, Recall and the Duration of Unemployment," NBER Working Papers 1825, National Bureau of Economic Research, Inc.
    2. William Fuchs, 2005. "Contracting with Repeated Moral Hazard and Private Evaluations," 2005 Meeting Papers 431, Society for Economic Dynamics.
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    8. Neal, Derek, 1993. "Supervision and Wages across Industries," The Review of Economics and Statistics, MIT Press, vol. 75(3), pages 409-17, August.
    9. Christopher A. Pissarides, 2000. "Equilibrium Unemployment Theory, 2nd Edition," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262161877, December.
    10. Rogerson, William P, 1985. "Repeated Moral Hazard," Econometrica, Econometric Society, vol. 53(1), pages 69-76, January.
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