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The Effect of Moral Hazard on Wage Inequality with On-the-Job Search and Employer Competition

Author

Listed:
  • Susanne Forstner

    (Institute for International Economic Studies)

  • Fernando Alvarez-Parra

    (CAF Development Bank of Latin America)

  • Arpad Abraham

    (European University Institute)

Abstract

In this paper we study the impact of moral hazard in labor contracts on the cross-sectional wage distribution, in particular, its effect on the extent of residual wage inequality. The tool of our analysis is a search model with job-to-job mobility and firm competition for workers. In our framework, firms oer long-term contracts to risk-averse workers in the presence of repeated moral hazard. For a quantitative analysis, we calibrate the model to match characteristics of the U.S. labor market derived from micro data from the mid-2000s. We find that, on balance, moral hazard increases residual wage inequality by around six percent. The direct effect of providing incentives through wage variation accounts for a moderate contribution to inequality increase. In addition, moral hazard affects the wage distribution through several indirect eects, as firms adjust the levels of eort implemented and the wage offers made to workers in response to increased effort costs. Through their particularly strong impact on the lower parts of the wage distribution, such effects contribute substantially to the overall rise in inequality. The main reason is that, under moral hazard, low wage workers spend signicantly less effort.

Suggested Citation

  • Susanne Forstner & Fernando Alvarez-Parra & Arpad Abraham, "undated". "The Effect of Moral Hazard on Wage Inequality with On-the-Job Search and Employer Competition," 2013 Meeting Papers 1034, Society for Economic Dynamics.
    • Handle: RePEc:red:sed013:1034
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