Fixed Wage Contracts Research Articles

Recruitment, Effort, and Retention Effects of Performance Contracts for Civil Servants: Experimental Evidence from Rwandan Primary Schools

This paper reports on a two-tiered experiment designed to separately identify the selection and effort margins of pay for performance (P4P). At the recruitment stage, teacher labor markets were randomly assigned to a “pay-for-percentile” or fixed-wage contract. Once recruits were placed, an unexpected, incentive-compatible, school-level re-randomization was performed so that some teachers who applied for a fixed-wage contract ended up being paid by P4P, and vice versa. By the second year of the study, the within-year effort effect of P4P was 0.16 standard deviations of pupil learning, with the total effect rising to 0.20 standard deviations after allowing for selection. (JEL C93, I21, J23, J33, J41, J45, O15)

Recruitment, Effort, and Retention Effects of Performance Contracts for Civil Servants: Experimental Evidence from Rwandan Primary Schools

This paper reports on a two-tiered experiment designed to separately identify the selection and effort margins of pay-for-performance (P4P). At the recruitment stage, teacher labor markets were randomly assigned to a pay- for-percentile or fixed-wage contract. Once recruits were placed, an unexpected, incentive-compatible, school-level re-randomization was performed, so that some teachers who applied for a fixed-wage contract ended up being paid by P4P, and vice versa. By the second year of the study, the within-year effort effect of P4P was 0.16 standard deviations of pupil learning, with the total effect rising to 0.20 standard deviations after allowing for selection.

The nature and drivers of contracts in cattle herding and management: The case of Ghana

We study the characteristics of contracts in cattle production in Ghana and explain variations in contract type using agency and transaction cost theory. In their study of pastoral groups, especially those in West Africa, anthropologists have distinguished between two categories of contracts in cattle production: cattle owner–herd manager contracts and herd manager–herdsman contracts. However, few studies have analysed the variations in contract type within each category. Using survey data from 342 cattle kraal owners, we explored the contract types under the two contract categories and analysed their drivers using crosstabulations. Contract types in each category can be explicit, with the reward given by the principal explicitly specified, or implicit and unspecified. Environmental uncertainty was associated with implicit contracts while for explicit contracts, kraal owners’ outside options or opportunity cost for monitoring was associated with fixed-wage contracts, subsidy-only contracts, and input contribution by kraal owners. The combination of moral hazard and measurement costs explained whether herdsmen were familial and not paid with milk or hired and paid with milk. Our findings provide further insights into the drivers of contract type.

Can Contracts Signal Social Norms? Experimental Evidence

We investigate whether incentive schemes signal social norms and thus affect behavior beyond their direct economic consequences. A one-shot principal–agent experiment is studied where prior to contract choice principals are informed about the past actions of other agents and thus have more information about norms of behavior. Compared with a setting in which principals are uninformed, agents exert substantially higher effort under a fixed wage contract when they are aware that an informed principal chose this contract. The informed principal’s choice apparently signals a norm not to exploit trust, which leads to more trustworthy behavior. This mechanism’s robustness is explored in further experiments. Data, as supplemental material, are available at http://dx.doi.org/10.1287/mnsc.2015.2336 . This paper was accepted by Uri Gneezy, behavioral economics.

Fixed-Wage Contracts and Monetary Non-neutrality

We study the importance of wage rigidities for the monetary policy transmission mechanism. Using uniquely rich micro data on Swedish wage negotiations, we isolate periods when the labor market is covered by fixed-wage contracts. Importantly, negotiations are coordinated in time but their seasonal patterns are far from deterministic. Using a two-regime VAR model, we document that monetary policy shocks have a larger impact on production during fixed-wage episodes as compared to the average response. The results do not seem to be driven by the periodic structure, nor the seasonality, of the renegotiation episodes. (JEL E23, E24, E52, J31, J41)

Institutions and Contract Enforcement

We conduct laboratory experiments where the market rules mimic labor market institutions and exogenously vary institutions to study the causal impact on subjects’ behaviors. We focus on rules analogous to dismissal barrier institutions, such as employment protection legislation, and on institutions allowing bonus pay. We find that when constrained to fixed wage contracts, dismissal barriers reduce efficiency but parties react by evolving rising compensation profiles. When the option to pay bonuses is introduced, this completely offsets the negative effects of dismissal barriers. In the absence of dismissal barriers, bonus pay reduces frequency of repeated interactions but leaves market efficiency unchanged.

Security bid auctions for agency contracts

A principal uses security bid auctions to award an incentive contract to one among several agents in the presence of hidden action and hidden information. Securities range from cash to equity and call options. “Steeper” securities are better surplus extractors, yet reduce effort incentives. In view of this trade-off, a hybrid share auction that includes a cash reward to the winner, a minimum share, and an option to call a fixed wage contract, tends to outperform all other auctions, although it is not an optimal mechanism. However, by adding output targets a hybrid share auction can (arbitrary closely) implement the optimal mechanism.

Employer moral hazard and wage rigidity. The case of worker owned and investor owned firms

This paper studies wage and employment rigidity in a labor relationship in different organizational contexts. In investor owned firms, if the contract allows for flexible wages, the employer may have an incentive to opportunistically claim low demand and cut wages. Anticipating the employer's opportunism, workers may demand a fixed-wage contract, which may lead to inefficient layoffs in the presence of negative demand shocks. In contrast, in cooperatives, where the employer does respond to workers, the risk of employer's opportunism diminishes and results in an equilibrium characterized by more flexible wages and fewer layoffs. By developing these arguments we challenge the traditional explanation of workers’ preference for fixed wages based on risk aversion. To support our claim, we develop a principal agent model in which there is incomplete information on both sides of the employment relation. We model both the case of investor-owned firms and worker cooperatives.

The Effect of Performance-Based Incentive Contracts on System 1 and System 2 Processing in Affective Decision Contexts: fMRI and Behavioral Evidence

ABSTRACTManagers may rely on emotional reactions to a setting to the detriment of economic considerations (“System 1 processing”), resulting in decisions that are costly for firms. While economic theory prescribes performance-based incentives to align goals and induce effort, psychology theory suggests that the salience of emotions is difficult to overcome without also inducing more deliberate consideration of both emotional and economic factors (“System 2 processing”). We link these perspectives by investigating whether performance-based incentives mitigate the costly influence of emotion by inducing more System 2 processing. Using functional magnetic resonance imaging and traditional experiments, we investigate managers' brain activity and choices under fixed wage and performance-based contracts. Under both, brain regions associated with System 1 processing are more active when emotion is present. Relative to fixed wage contracts, performance-based contracts induce System 2 processing in emotional contexts beyond that observed absent emotion, and decrease the proportion of economically costly choices.Data Availability: Contact the authors.

Do Performance-Based Incentives Induce Analytical Processing in Affective Decision-Making Contexts? fMRI and Behavioral Evidence

Managers may rely on emotional reactions to a setting to the detriment of economic considerations (“System 1 processing”), resulting in decisions that are costly for firms. While economic theory prescribes performance-based incentives to align goals and induce effort, psychology theory suggests that the salience of emotions is difficult to overcome without also inducing more deliberate consideration of both emotional and economic factors (“System 2 processing”). We link these perspectives by investigating whether performance-based incentives mitigate the costly influence of emotion by inducing more System 2 processing. Using functional magnetic resonance imaging and traditional experiments, we investigate managers’ brain activity and choices under fixed wage and performance-based contracts. Under both, brain regions associated with System 1 processing are more active when emotion is present. Relative to fixed wage contracts, performance-based contracts induce System 2 processing in emotional contexts beyond that observed absent emotion, and decrease the proportion of economically costly choices.

Security Bid Auctions for Agency Contracts

A principal uses security bid auctions to award an incentive contract to one among several agents in the presence of hidden action and hidden information. Securities range from cash to equity and call options. “Steeper” securities are better surplus extractors that narrow the gap between the two highest valuations, yet reduce effort incentives. In view of this trade-off, a hybrid share auction that includes a (possibly negative) cash reward to the winner, a minimum share, and an option to call a fixed wage contract, tends to outperform all other auctions, although it is not an optimal mechanism. However, by adding output targets to hybrid share auctions one can (arbitrary closely) implement the optimal mechanism.

Security Bid Auctions for Agency Contracts

A principal uses security bid auctions to award an incentive contract to one among several agents in the presence of hidden action and hidden information. Securities range from cash to equity and call options. “Steeper†securities are better surplus extractors that narrow the gap between the two highest valuations, yet reduce effort incentives. In view of this trade-off, a hybrid share auction that includes a (possibly negative) cash reward to the winner, a minimum share, and an option to call a fixed wage contract, tends to outperform all other auctions, although it it is not an optimal mechanism. However, by adding output targets to hybrid share auctions one can (arbitrary closely) implement the optimal mechanism.

Contract Form, Wage Flexibility, and Employment

We begin with two uncontroversial hypotheses - firm productivity is expensive to measure and employment entails relationship-specific investments. These assumptions imply that firms would optimally choose fixed-wage contracts, and complement these with bonus pay when measuring employee performance is not too costly. These assumptions imply that under an optimal employment contract hours of work is less responsive, while total compensation is more responsive to shocks under bonus-pay contracts compared to fixed wage contracts. Using data from the Panel Study of Income Dynamics (PSID) where shocks are proxied using the local unemployment rate, we find strong support for these two implications.

A Dynamic Multitask Model: Fixed Wage Contracts and Effort Allocation Problems

Holmstrom and Milgrom (1991) proposed a multitask principal-agent model in which the principal's utility is determined by several tasks the agent engages in. Their results depend on externalities between tasks and several assumptions related to the agent's eort. In this paper, we override certain assumptions (such as, the agent's eort can be negative and disutility is a non-increasing function of the eort up to some level) and obtain the similar outcomes in deriving …xed wage contracts and eort allocation problems. We further introduce timing, outputs that are unveri…able (such as leadership and collegial work), and …rm-speci…c knowledge as observed in actual labor markets and practices. This restructure also allows us to develop a multitask model without externalities, allowing us to study an optimal wage pro…le and …nd the optimal timing to sign a contract. Our model predicts that in industries where unveri…able outputs are valued, the more frequently the wage contract is renewed.

The fixed wage puzzle: Why profit sharing is so hard to implement

Profit sharing arrangements Pareto-dominate fixed wage contracts, but are (far) less than ubiquitous. We account for this fixed wage puzzle by adopting a perspective of bounded rationality. Specifically, plausible share arrangements are not generally acceptable to both firms and unions.

Land tenure, population, and long-run growth

This paper brings together the development literature on land tenure with current research on population and long-run growth. Landowners make a decision between fixed rent, fixed wage, and sharecropping contracts to hire tenants to operate their land. The choice of tenure contract affects the share of output going to tenants, and within a simple unified growth model, this affects the relative price of food and therefore fertility. Fixed wage contracts elicit the lowest fertility rate and fixed rent contracts the highest, with sharecropping as an intermediate case. The implications of this for long-run growth depend on the assumptions one makes about scale effects in the aggregate economy. With increasing returns to scale, as in several models of innovation, fixed rent contracts imply higher growth through a market size effect. Without such increasing returns, though, fixed rent contracts reduce output per capita through a depressing effect on accumulation.

Block recursive equilibria for stochastic models of search on the job

We develop a general stochastic model of directed search on the job. Directed search allows us to focus on a Block Recursive Equilibrium (BRE) where agents' value functions, policy functions and market tightness do not depend on the distribution of workers over wages and unemployment. We formally prove existence of a BRE under various specifications of workers' preferences and contractual environments, including dynamic contracts and fixed-wage contracts. Solving a BRE is as easy as solving a representative agent model, in contrast to the analytical and computational difficulties in models of random search on the job.

Labor Market Pooling, Outsourcing and Labor Contracts

Economic regions, such as urban agglomerations, face external demand and price shocks that produce income risk. Workers in large and diversified agglomerations may benefit from reduced wage volatility, while firms may outsource the production of intermediate goods and realize benefits from Chamberlinian externalities. Firms may also protect workers from wage risks through fixed wage contracts. This paper explores the relationships between firms’ risks, workers’ contracts, and the structure of production in cities.

Labor Market Pooling, Outsourcing and Contracts in Chamberlinian Regions

Economic regions, such as urban agglomerations, face external demand and price shocks that produce income risk. Workers in large and diversified agglomerations may benefit from reduced wage volatility, while firms may outsource the production of intermediate goods and realize benefits from Chamberlinian externalities. Firms may also protect workers from wage risks through fixed wage contracts. This paper explores the relationships between firms' risks, workers' contracts, and the structure of production in cities.

Adverse Selection, Seller Effort, and Selection Bias

1. IntroductionResearchers use several approaches to identify adverse selection.1 Genesove (1993) tests the proposition that, in a lemons market, prices inversely relate with observable seller characteristics that correlate with seller incentives to select goods adversely. Genesove examines the proposition in used automobile auctions. Chezum and Wimmer (1997) examine the proposition in thoroughbred racehorse markets, arguing that sellers with a high propensity to race horses should receive, on average, lower prices. Both Genesove (1993) and Chezum and Wimmer (1997) use data limited to market transactions. Wimmer and Chezum (2003) model adverse selection as a case of Heckman's (1979) sample selection bias and examine the correlation between errors in participation and price equations to study how third party certification could alleviate the effect of adverse selection in thoroughbred auctions.2In this paper, we extend the work of Genesove (1993) and Chezum and Wimmer (1997) and Wimmer and Chezum (2003) by characterizing adverse selection as a sample selection problem in a setting in which sellers possess (1) an informational advantage over buyers and (2) characteristics that correlate with both seller incentives to select goods adversely and the quality of goods produced. In such a setting, the relationship between prices and seller characteristics proves ambiguous, and researchers cannot easily disentangle adverse selection from quality effects. We show that Heckman's sample selection framework disentangles the correlation between a seller's characteristic and the effect of the selection decision on price from the correlation between a seller's characteristic and the quality of goods produced by a seller.The notion that the decision to sell goods relates to the quality of goods produced is not new. For example, Kim (1985) developed an adverse selection model in which car owners' maintenance and upkeep decisions affected the quality of used cars. Kim showed that allowing owners to affect the quality of goods could, under certain conditions, lead to an equilibrium in which the expected quality of used cars sold exceeds the expected quality of cars not sold. Similarly, we develop a theoretical model that extends a standard adverse selection specification by allowing owners (potential sellers) to improve a good's quality by expending unobserved effort. We show that owner effort only affects the adverse selection equilibrium when owners choose effort before they make the sell-retain decision.Owners decide whether to sell or retain a good once they observe their good's innate quality. Because buyers do not observe owner effort, the owner's dominant strategy is to expend zero effort on goods they will surely sell. Essentially, the model collapses to a standard moral hazard model, such as a fixed wage contract, in which employers cannot observe employee effort, and employees exert the necessary minimum effort to avoid dismissal. Because equilibrium effort equals zero, quality effects do not alter seller selection decisions and, therefore, the adverse selection equilibrium.Owners who must exert effort before they observe innate quality know only the probability that they will sell their goods and that the expected return to effort increases in the probability of retaining those goods. Because the probability of retention increases in seller incentives to select goods adversely, sellers who more likely select goods adversely also exert more effort. In this version of the model, no clear relationship exists between the expected quality of goods sold and the seller characteristics that Genesove (1993), and Chezum and Wimmer (1997) use to measure adverse selection. The model shows that uncertainty about whether a good will be sold partially solves the hidden action problem, in which owners underprovide effort and lessen the effect of adverse selection on markets.The notion that both adverse selection and moral hazard are important in markets affected by asymmetric information is well understood. …