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Recursive Contracts


  • Bardsley, P.


We model career design as a recursive contract design problem in an overlapping generations firm. Agents live two periods. In period 1 they may be hired as employees, paid a wage, and produce output. In period 2 they may be promoted to become joint owners (partners) of the firm, producing no output directly, but setting the rules and receiving the residual income. Professional partnerships, such as the traditional law firm, are often organized like this. Employees are motivated not only by the wage but by the possibility of promotion to the partnership, and the opportunity to set the rules in the next period; the reward structure is thus recursive. The contracts that emerge in this environment are always inefficient. In many circumstances the inefficiency takes the form of “rat-race” contracts that specify very low wages and an inefficiently high level of effort. This conclusion seems to be robust to a range of variations in the environment.

Suggested Citation

  • Bardsley, P., 2001. "Recursive Contracts," Department of Economics - Working Papers Series 797, The University of Melbourne.
  • Handle: RePEc:mlb:wpaper:797

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    References listed on IDEAS

    1. Meyer, Margaret A & Vickers, John, 1997. "Performance Comparisons and Dynamic Incentives," Journal of Political Economy, University of Chicago Press, vol. 105(3), pages 547-581, June.
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    4. Gibbons, Robert & Murphy, Kevin J, 1992. "Optimal Incentive Contracts in the Presence of Career Concerns: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 100(3), pages 468-505, June.
    5. Stoughton, Neal M & Talmor, Eli, 1999. "Managerial Bargaining Power in the Determination of Compensation Contracts and Corporate Investment," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 40(1), pages 69-93, February.
    6. Christopher Ferrall, 1996. "Promotions and Incentives in Partnerships: Evidence from Major U.S. Law Firms," Canadian Journal of Economics, Canadian Economics Association, vol. 29(4), pages 811-827, November.
    7. Carr, Jack & Mathewson, Frank, 1990. "The Economics of Law Firms: A Study in the Legal Organization of the Firm," Journal of Law and Economics, University of Chicago Press, vol. 33(2), pages 307-330, October.
    8. Jacques Cremer, 1986. "Cooperation in Ongoing Organizations," The Quarterly Journal of Economics, Oxford University Press, vol. 101(1), pages 33-49.
    9. George Akerlof, 1976. "The Economics of Caste and of the Rat Race and Other Woeful Tales," The Quarterly Journal of Economics, Oxford University Press, vol. 90(4), pages 599-617.
    10. Landers, Renee M & Rebitzer, James B & Taylor, Lowell J, 1996. "Rat Race Redux: Adverse Selection in the Determination of Work Hours in Law Firms," American Economic Review, American Economic Association, vol. 86(3), pages 329-348, June.
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    Cited by:

    1. Peter Bardsley & Katerina Sherstyuk, 2001. "Rat Races and Glass Ceilings- Career Paths in Organizations," Working Papers 200106, University of Hawaii at Manoa, Department of Economics.

    More about this item


    recursive contracts; mechanism design; overlapping generations; rat-race;

    JEL classification:

    • K12 - Law and Economics - - Basic Areas of Law - - - Contract Law
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation


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