Contracting in Peer Networks

67 Pages Posted: 27 Jan 2021 Last revised: 17 Jul 2022

See all articles by Peter M. DeMarzo

Peter M. DeMarzo

Stanford Graduate School of Business; National Bureau of Economic Research (NBER)

Ron Kaniel

University of Rochester - Simon Business School; CEPR

Multiple version iconThere are 3 versions of this paper

Date Written: January 2021

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.

Suggested Citation

DeMarzo, Peter M. and Kaniel, Ron, Contracting in Peer Networks (January 2021). NBER Working Paper No. w28378, Available at SSRN: https://ssrn.com/abstract=3772617

Peter M. DeMarzo (Contact Author)

Stanford Graduate School of Business ( email )

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National Bureau of Economic Research (NBER)

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Ron Kaniel

University of Rochester - Simon Business School ( email )

Rochester, NY 14627
United States

HOME PAGE: http://rkaniel.simon.rochester.edu

CEPR ( email )

London
United Kingdom

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