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Profit-Sharing as the Optimal Wage Contract

Author

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  • Kenjiro Hori

    (Department of Economics, Mathematics & Statistics, Birkbeck)

Abstract

This paper analyses the optimal wage contract when firms face demand uncertainty and workers care about employment stability. Workers choose the firm that offers the highest utility taking into account the future lay-off probabilities; firms choose the wage contract that maximises the residual share of the gains from production. For risk-neutral workers this occurs with any efficient wage contract so long as it matches the ex-ante outside option of the workers, i.e. all feasible efficient contracts are optimal. The feasibility is proved for the efficient profit-sharing case. For risk-averse workers with variable effort supply, profit-sharing contracts are further shown to provide effort incentives through both their efficiency wage and performance-related payout effects. The paper thus promotes profit-sharing contracts not only on the grounds of employment stability, but also on the basis of its efficiency and incentive effects.

Suggested Citation

  • Kenjiro Hori, 2006. "Profit-Sharing as the Optimal Wage Contract," Birkbeck Working Papers in Economics and Finance 0601, Birkbeck, Department of Economics, Mathematics & Statistics.
  • Handle: RePEc:bbk:bbkefp:0601
    as

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    File URL: http://www.bbk.ac.uk/ems/research/wp/PDF/BWPEF0601.pdf
    File Function: First version, 2005
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    References listed on IDEAS

    as
    1. Lazear, Edward P & Rosen, Sherwin, 1981. "Rank-Order Tournaments as Optimum Labor Contracts," Journal of Political Economy, University of Chicago Press, vol. 89(5), pages 841-864, October.
    2. Freeman, Richard B. & Weitzman, Martin L., 1987. "Bonuses and employment in Japan," Journal of the Japanese and International Economies, Elsevier, vol. 1(2), pages 168-194, June.
    3. Canice Prendergast, 1999. "The Provision of Incentives in Firms," Journal of Economic Literature, American Economic Association, vol. 37(1), pages 7-63, March.
    4. Weitzman, Martin L, 1985. "The Simple Macroeconomics of Profit Sharing," American Economic Review, American Economic Association, vol. 75(5), pages 937-953, December.
    5. Shapiro, Carl & Stiglitz, Joseph E, 1984. "Equilibrium Unemployment as a Worker Discipline Device," American Economic Review, American Economic Association, vol. 74(3), pages 433-444, June.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    feasiblity; optimal wage contract; profit-share; efficiency;

    JEL classification:

    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
    • J23 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Labor Demand

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