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Reputation and Hierarchy in Dynamic Models of Employment

W. Bentley Macleod and James Malcomson ()

Working Paper from Economics Department, Queen's University

Abstract: This paper explores the nature of employment contracts in a dynamic model when workers vary by unobserved ability, and there is moral hazard on both sides of the contract. We find that even though a worker's ability is chosen from a continuum, the equilibrium contract is characterized by a hierarchy consisting of a finite number of ranks. Reputation effects are modelled as a Bayesian game, and are needed to ensure workers will not shirk. Workers are not immediately assigned to the appropriate rank, but are promoted through the ranks until they reach a level consistent with their ability.

Date: 1985
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