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Equilibrium Incentive Contracts

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  • Moen, Espen R.
  • Rosén, Åsa

    () (Swedish Institute for Social Research, Stockholm University)

Abstract

We study a labour market in which firms can observe workers’ output but not their effort, and in which a worker’s productivity in a given firm depends on a worker-firm specific component, unobservable for the firm. Firms offer wage contracts that optimally trade off effort and wage costs. As a result, employed workers enjoy rents, which in turn create unemployment. We show that the incentive power of the equilibrium wage contract is constrained socially efficient in the absence of unemployment benefits. We then apply the model to explain the recent increase in performance-pay contracts. Within our model, this can be explained by three different factors: (i) increased importance of non-observable effort, (ii) a fall in the marginal tax rate, (iii) a reduction in the heterogeneity of workers performing the same task. The likely effect of all three factors is an increase in the equilibrium unemployment rate.

Suggested Citation

  • Moen, Espen R. & Rosén, Åsa, 2003. "Equilibrium Incentive Contracts," Working Paper Series 3/2003, Stockholm University, Swedish Institute for Social Research.
  • Handle: RePEc:hhs:sofiwp:2003_003
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    References listed on IDEAS

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    1. Ritter, Joseph A & Taylor, Lowell J, 1994. "Workers as Creditors: Performance Bonds and Efficiency Wages," American Economic Review, American Economic Association, vol. 84(3), pages 694-704, June.
    2. Daron Acemoglu, 1999. "Changes in Unemployment and Wage Inequality: An Alternative Theory and Some Evidence," American Economic Review, American Economic Association, vol. 89(5), pages 1259-1278, December.
    3. Edward P. Lazear, 2000. "Performance Pay and Productivity," American Economic Review, American Economic Association, vol. 90(5), pages 1346-1361, December.
    4. MacLeod, W. Bentley & Malcomson, James M., 1993. "Wage premiums and profit maximization in efficiency wage models," European Economic Review, Elsevier, vol. 37(6), pages 1223-1249, August.
    5. Carmichael, Lorne, 1985. "Can Unemployment Be Involuntary? Comment [Equilibrium Unemployment as a Worker Discipline Device]," American Economic Review, American Economic Association, vol. 75(5), pages 1213-1214, December.
    6. Acemoglu, Daron & Shimer, Robert, 1999. "Holdups and Efficiency with Search Frictions," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 40(4), pages 827-849, November.
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    9. Foster, James E & Wan, Henry Y, Jr, 1984. "Involuntary Unemployment as a Principal-Agent Equilibrium," American Economic Review, American Economic Association, vol. 74(3), pages 476-484, June.
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    11. Oliver Hart & Bengt Holmstrom, 1986. "The Theory of Contracts," Working papers 418, Massachusetts Institute of Technology (MIT), Department of Economics.
    12. James D. Montgomery, 1991. "Equilibrium Wage Dispersion and Interindustry Wage Differentials," The Quarterly Journal of Economics, Oxford University Press, vol. 106(1), pages 163-179.
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    Citations

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    Cited by:

    1. Moen, Espen R & Rosén, Åsa, 2006. "Incentives in Competitive Search Equilibrium and Wage Rigidity," CEPR Discussion Papers 5554, C.E.P.R. Discussion Papers.
    2. Bamikole, Oluwafemi, 2013. "The Impact of Minimum Wage on Average Earnings in the Caribbean using Two-Selected Countries, Trinidad and Tobago and Jamaica (1980-2011 and 1997-2011)," MPRA Paper 57363, University Library of Munich, Germany.
    3. Ulf Axelson & Philip Bond, 2011. "Investment banking careers: An equilibrium theory of overpaid jobs," FMG Discussion Papers dp690, Financial Markets Group.

    More about this item

    Keywords

    Incentives; Contracts; Unemployment; efficiency;

    JEL classification:

    • E24 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Employment; Unemployment; Wages; Intergenerational Income Distribution; Aggregate Human Capital; Aggregate Labor Productivity
    • J30 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - General
    • J41 - Labor and Demographic Economics - - Particular Labor Markets - - - Labor Contracts

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