Equilibrium Incentive Contracts

Espen R. Moen and Åsa Rosén ()
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Åsa Rosén: Swedish Institute for Social Research, Stockholm University, Postal: SE-106 91 Stockholm, Sweden

No 3/2003, Working Paper Series from Swedish Institute for Social Research

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.

Keywords: Incentives; Contracts; Unemployment; efficiency (search for similar items in EconPapers)
JEL-codes: E24 J30 J41 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mac
Date: 2003-03-01
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Working Paper: Equilibrium Incentive Contracts (2003)
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