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Market-based incentives

Author

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  • Borys Grochulski
  • Yuzhe Zhang

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.

Suggested Citation

  • Borys Grochulski & Yuzhe Zhang, 2013. "Market-based incentives," Working Paper 13-05, Federal Reserve Bank of Richmond.
  • Handle: RePEc:fip:fedrwp:13-05
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    References listed on IDEAS

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    Cited by:

    1. Grochulski, Borys & Zhang, Yuzhe, 2016. "Optimal Contracts with Reflection," Working Paper 16-14, Federal Reserve Bank of Richmond, revised 27 Jan 2017.
    2. Spear, Stephen E. & Wang, Cheng, 2005. "When to fire a CEO: optimal termination in dynamic contracts," Journal of Economic Theory, Elsevier, vol. 120(2), pages 239-256, February.
    3. repec:oup:restud:v:84:y:2017:i:1:p:182-236. is not listed on IDEAS
    4. Peter M. Demarzo & Yuliy Sannikov, 2017. "Learning, Termination, and Payout Policy in Dynamic Incentive Contracts," Review of Economic Studies, Oxford University Press, vol. 84(1), pages 182-236.

    More about this item

    Keywords

    Labor market;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • J31 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Wage Level and Structure; Wage Differentials
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
    • M12 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Administration - - - Personnel Management; Executives; Executive Compensation
    • M52 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics - - - Compensation and Compensation Methods and Their Effects

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