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High Compensation Creates a Ratchet Effect

  • Gersbach, Hans

    ()

    (ETH Zurich)

  • Glazer, Amihai

    ()

    (University of California, Irvine)

We consider a firm which pays a worker for his effort over several periods. The more the firm pays in one period, the wealthier the worker is in the following periods, and so the more he must be paid for a given effort. This wealth effect can induce an employer to pay little initially and more later on. For related reasons, the worker may work harder than the employer prefers. The incentive contracts firms offer may therefore cap the worker’s earnings. Lastly, this wealth ratchet effect can induce excessive firing and turnover.

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File URL: http://ftp.iza.org/dp1143.pdf
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Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 1143.

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Length: 28 pages
Date of creation: May 2004
Date of revision:
Publication status: published in: Economic Journal, 2009, 119 (539), 1208 - 1224
Handle: RePEc:iza:izadps:dp1143
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  1. Abowd, J.M. & Kramarz, F. & Margolis, D.N., 1995. "High-Wage Workers and High-Wage Firms," Cahiers de recherche 9503, Centre interuniversitaire de recherche en économie quantitative, CIREQ.
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  7. Drew Fudenberg & Bengt Holmstrom & Paul Milgrom, 1987. "Short-Term Contracts and Long-Term Agency Relationships," Working papers 468, Massachusetts Institute of Technology (MIT), Department of Economics.
  8. Macleod, W.B. & Kenemoto, Y., 1990. "The Ratchet Effect and the Market for Second-Hand Workers," Cahiers de recherche 9027, Universite de Montreal, Departement de sciences economiques.
  9. Lazear, Edward P, 1986. "Salaries and Piece Rates," The Journal of Business, University of Chicago Press, vol. 59(3), pages 405-31, July.
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