Contracting in Peer Networks
68 Pages Posted: 18 Feb 2021 Last revised: 26 Feb 2022
Date Written: January 16, 2021
We consider multi-agent multi-firm contracting when agents benchmark their wages to those of their peers, using weights that vary within and across firms. When a single principal commits to a public contract, optimal contracts hedge relative wage risk without sacrificing efficiency. But compensation benchmarking undoes performance benchmarking, causing wages to load positively on peer output, and asymmetries in peer effects can be exploited to enhance profits. With multiple principals a “rat race” emerges: agents are more productive, with effort that can exceed the first-best, but higher wages reduce profits and undermine efficiency. Wage transparency and disclosure requirements exacerbate these effects.
Keywords: contracting, peer performance, keeping up with Joneses, peer, relative wage, network, moral hazard
JEL Classification: d62, d85,d86, g41, j41, m52, g30
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