Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/102701
Authors: 
Bannier, Christina E.
Feess, Eberhard
Packham, Natalie
Year of Publication: 
2014
Series/Report no.: 
CFS Working Paper Series 475
Abstract: 
This paper examines the effect of imperfect labor market competition on the efficiency of compensation schemes in a setting with moral hazard, private information and risk-averse agents. Two vertically differentiated firms compete for agents by offering contracts with fixed and variable payments. Vertical differentiation between firms leads to endogenous, type-dependent exit options for agents. In contrast to screening models with perfect competition, we find that existence of equilibria does not depend on whether the least-cost separating allocation is interim efficient. Rather, vertical differentiation allows the inferior firm to offer (cross-)subsidizing fixed payments even above the interim efficient level. We further show that the efficiency of variable pay depends on the degree of competition for agents: For small degrees of competition, low-ability agents are under-incentivized and exert too little effort. For large degrees of competition, high-ability agents are over-incentivized and bear too much risk. For intermediate degrees of competition, however, contracts are second-best despite private information.
Subjects: 
Incentive compensation
screening
imperfect labor market competition
vertical differentiation
cross-subsidy
JEL: 
D82
D86
J31
J33
Document Type: 
Working Paper

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