Essays on Optimal Contract Design

Download or read book Essays on Optimal Contract Design written by Jin Xu and published by . This book was released on 2013 with total page 136 pages. Available in PDF, EPUB and Kindle. Book excerpt: The optimal compensation contract is a very important issue for firms. Some empirical findings of wage structure in internal labor market are puzzling. For example, why are the compensation of workers more compressed than predicted by the classical theories. Why is the wage structure convex in hierarchical firms? This dissertation explores various important factors which may affect the optimal contract in the internal labor market. The first chapter characterizes the optimal contract when workers in the workplace care not only about theirown wage but alos their co-workers' wage. Specifically, I assume that workers are inequity averse model of Fehr and Schmidt (1999), I derive that the optimal wage structure is more compressed with inequity averse workers than with the standard workers. Inequity aversion among workers can also help explain the internal organization of the firms. For example, inequity aversion among workers may lead firms to employ only high productivity workers, even though the marginal product of a low productivity worker is higher than the worker's marginal cost. Chapter 2 examines two possibile realistic explanations for the convex wage structure in the hierarchical firms. Based on the multi-round tournament model of Rosen (1986), we incorporate heterogeneous stage effects. The first extension that can generate the convex wage structure is that the number of workers competing increases with the hierarchical levels. The second explanation is that the returns to effort increase with the hierarchical levels, which cannot generate the convex wage structure unless further assumptions added on optimal effort levels and cost functions. The third chapter investigates the underlying assumption in Chapter 1 that people are inequity averse to ex-ante payoff differentials. Specifically, an online survey is conducted to test whether ex ante or ex post fairness views affect people's decision making in a social context. I find that the ex post fairness views do make an important role in people's decision making. The results of the survey data do not support the model of inequity aversion.