Working Paper: NBER ID: w16325
Authors: Gary Charness; Peter Kuhn; Marie-Claire Villeval
Abstract: In labor markets, the ratchet effect refers to a situation where workers subject to performance pay choose to restrict their output, because they rationally anticipate that firms will respond to higher output levels by raising output requirements or cutting pay. We model this effect as a multi-period principal-agent problem with hidden information, and study its robustness to labor market competition both theoretically and experimentally. Consistent with our theoretical model, we observe substantial ratchet effects in the absence of competition, which is nearly eliminated when competition is introduced; this is true regardless of whether market conditions favor firms or workers.
Keywords: ratchet effect; labor market; competition; performance pay; principal-agent problem
JEL Codes: C91; D23; D82; J22; J3; J41; L14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Anticipated future costs of revealing high talent (D29) | Lower current output (D15) |
| Competition (L13) | Reduced ratchet effect (D15) |
| Competition (L13) | Better outside options for workers (J63) |
| Competition (L13) | Decreased incentive to conceal abilities (D83) |
| Competition alters strategic interactions (L13) | Shift from pooling equilibria to separating equilibria (D51) |
| High-talent workers are more likely to accept contracts in competitive settings (J41) | Higher output choices (E23) |