On the Efficiency of the Rank-Order Contract under Moral Hazard and Adverse Selection

Jungyoll Yun

Journal of Labor Economics, 1997, vol. 15, issue 3, 466-94

Abstract: This article analyzes the efficiency of the rank-order contract for a finite number of risk-neutral agents under both moral hazard and adverse selection. The first-best outcome is shown to be supported by a set of rank-order contracts which penalize a small fraction of agents but do so heavily. The article also shows how these rank-order contracts compare with those giving a large prize to few agents. Finally, the article provides an informal argument for why firms do not follow a penalty-giving rank-order contract in their promotion policies as often as the theory predicts. Copyright 1997 by University of Chicago Press.

Date: 1997
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