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Market-based incentives

Author

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  • Grochulski, Borys
  • Zhang, Yuzhe

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

  • Grochulski, Borys & Zhang, Yuzhe, 2013. "Market-based incentives," MPRA Paper 45576, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:45576
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    References listed on IDEAS

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    Cited by:

    1. Borys Grochulski & Yuzhe Zhang, 2016. "Optimal Contracts with Reflection," Working Paper 16-14, Federal Reserve Bank of Richmond.
    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. 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.
    4. Felix Feng, 2018. "Dynamic Compensation under Uncertainty Shocks and Limited Commitment," 2018 Meeting Papers 159, Society for Economic Dynamics.
    5. Wang, Cheng & Yang, Youzhi, 2022. "Optimal CEO turnover," Journal of Economic Theory, Elsevier, vol. 203(C).

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    More about this item

    Keywords

    Market-based incentive; Career Concerns; Endogenous outside option; Limited commitment; Private information; Wage contract;
    All these keywords.

    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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