Working Paper: NBER ID: w28378
Authors: Peter M. DeMarzo; Ron Kaniel
Abstract: We consider multi-agent multi-firm contracting when agents benchmark their wages to a weighted average of their peers, where weights may vary within and across firms. Despite common shocks, compensation benchmarking can undo performance benchmarking, so that wages load positively rather than negatively on peer output. Although contracts appear inefficient, when a single principal commits to a public contract, the optimal contract hedges agents’ relative wage risk without sacrificing efficiency. Moreover, the principal can exploit any asymmetries in peer effects to enhance profits. With multiple principals, or a principal that is unable to commit, a “rat race” emerges in which agents are more productive, but wages increase even more, reducing profits and undermining efficiency. Effort levels are too high rather than too low, and can exceed first best. Wage transparency and disclosure requirements exacerbate these effects.
Keywords: No keywords provided
JEL Codes: D85; D86; G3; G4; J3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| agents' relative wage concerns (J31) | optimal contracts (D86) |
| optimal contracts (D86) | effort levels (D29) |
| peer output (G35) | wage contracts (J41) |
| peer influences (C92) | equilibrium effort (D50) |
| multiple principals (M12) | rat race (J29) |
| rat race (J29) | productivity (O49) |
| rat race (J29) | wages (J31) |
| wages (J31) | profits (L21) |
| peer influences (C92) | profitability (L21) |