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Profit-Sharing as the Optimal Wage Contract

  • Kenjiro Hori

    (Department of Economics, Mathematics & Statistics, Birkbeck)

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.

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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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Paper provided by Birkbeck, Department of Economics, Mathematics & Statistics in its series Birkbeck Working Papers in Economics and Finance with number 0601.

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Date of creation: Jan 2006
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Handle: RePEc:bbk:bbkefp:0601
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  1. 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.
  2. Weitzman, Martin L, 1985. "The Simple Macroeconomics of Profit Sharing," American Economic Review, American Economic Association, vol. 75(5), pages 937-53, December.
  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. Shapiro, Carl & Stiglitz, Joseph E, 1984. "Equilibrium Unemployment as a Worker Discipline Device," American Economic Review, American Economic Association, vol. 74(3), pages 433-44, June.
  5. 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 841-64, October.
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