High Compensation Creates a Ratchet Effect

28 Pages Posted: 20 May 2004

See all articles by Hans Gersbach

Hans Gersbach

ETH Zurich - CER-ETH -Center of Economic Reseaarch; IZA Institute of Labor Economics; CESifo (Center for Economic Studies and Ifo Institute); Centre for Economic Policy Research (CEPR)

Amihai Glazer

University of California, Irvine - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: May 2004

Abstract

We consider a firm which pays a worker for his effort over several periods. The more the firm pays in one period, the wealthier the worker is in the following periods, and so the more he must be paid for a given effort. This wealth effect can induce an employer to pay little initially and more later on. For related reasons, the worker may work harder than the employer prefers. The incentive contracts firms offer may therefore cap the worker's earnings. Lastly, this wealth ratchet effect can induce excessive firing and turnover.

Keywords: principal-agent, compensation, moral hazard, wealth effects, Ratchet effects, high-powered incentives

JEL Classification: D80, J30, J60

Suggested Citation

Gersbach, Hans and Glazer, Amihai, High Compensation Creates a Ratchet Effect (May 2004). IZA Discussion Paper No. 1143. Available at SSRN: https://ssrn.com/abstract=546123

Hans Gersbach (Contact Author)

ETH Zurich - CER-ETH -Center of Economic Reseaarch ( email )

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Zurich, 8092
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IZA Institute of Labor Economics

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CESifo (Center for Economic Studies and Ifo Institute)

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Germany

Centre for Economic Policy Research (CEPR)

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United Kingdom

Amihai Glazer

University of California, Irvine - Department of Economics ( email )

3151 Social Science Plaza
Irvine, CA 92697-5100
United States
949-854-6563 (Phone)
949-824-2182 (Fax)

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