Equilibrium Incentive Contracts and Efficiency Wages

Espen Moen () and Åsa Rosén

Journal of the European Economic Association, 2006, vol. 4, issue 6, 1165-1192

Abstract: We analyze the optimal (efficiency) wage contract when output is contractible but firms neither observe the workers' effort nor their match-specific productivity. Firms offer wage contracts that optimally trade off effort and wage costs. As a result, employed workers enjoy rents, which in turn creates unemployment. Nonetheless, the incentive power of the equilibrium wage contract is constrained efficient in the absence of taxes and unemployment benefits. We also show that more high-powered incentive contracts tend to be associated with higher equilibrium unemployment rates. (JEL: E24, J30, J41) (c) 2006 by the European Economic Association.

Date: 2006
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