Incentive Schemes, Private Information and the Double-Edged Role of Competition for Agents

56 Pages Posted: 3 Jan 2013 Last revised: 12 Jul 2016

See all articles by Christina E. Bannier

Christina E. Bannier

Justus-Liebig-University Giessen

Eberhard Feess

Frankfurt School of Finance & Management

Natalie Packham

Berlin School of Economics and Law; Humboldt University Berlin

Markus Walzl

University of Innsbruck

Date Written: June 29, 2016

Abstract

This paper examines the effect of imperfect labor market competition on the efficiency of compensation schemes in a setting with moral hazard and risk-averse agents, who have private information on their productivity. Two vertically differentiated firms compete for agents by offering contracts with fixed and variable payments. The superior firm employs both agent types in equilibrium, but the competitive pressure exerted by the inferior firm has a strong impact on contract design: For high degrees of vertical differentiation, i.e. low competition, low-ability agents are under-incentivized and exert too little effort. For high degrees of competition, high-ability agents are over-incentivized and bear too much risk. For a range of intermediate degrees of competition, however, agents' private information has no impact and both contracts are second-best. Interim efficiency of the least-cost separating allocation in the inferior firm is a sufficient condition for equilibrium existence. If this is violated, there can only be equilibria where the inferior firm "overbids", i.e. where it would not break even when attracting both agent types. Adding horizontal differentiation allows for pure-strategy equilibria even when there would be no equilibrium without overbidding in the pure vertical model, but equilibria with overbidding fail to exist.

Keywords: Incentive compensation, screening, imperfect labor market competition, vertical differentiation, horizontal differentiation, risk aversion

JEL Classification: D82, D86, J31, J33

Suggested Citation

Bannier, Christina E. and Feess, Eberhard and Packham, Natalie and Walzl, Markus, Incentive Schemes, Private Information and the Double-Edged Role of Competition for Agents (June 29, 2016). Available at SSRN: https://ssrn.com/abstract=2196027 or http://dx.doi.org/10.2139/ssrn.2196027

Christina E. Bannier

Justus-Liebig-University Giessen ( email )

Licher Str. 62
Gießen, 35394
Germany
+49 641 99 22551 (Phone)

Eberhard Feess

Frankfurt School of Finance & Management ( email )

Adickesallee 32-34
Frankfurt am Main, 60322
Germany

Natalie Packham (Contact Author)

Berlin School of Economics and Law ( email )

Badensche Strasse 50-51
Berlin, D-10825
Germany

HOME PAGE: http://www.packham.net

Humboldt University Berlin ( email )

Unter den Linden 6
Berlin, AK Berlin 10099
Germany

Markus Walzl

University of Innsbruck ( email )

Universitätsstraße 15
Innsbruck, Innsbruck 6020
Austria

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