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Contracting in Peer Networks

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  • Kaniel, Ron
  • DeMarzo, Peter

Abstract

We consider multi-agent multi-firm contracting when agents benchmark their wages to 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.

Suggested Citation

  • Kaniel, Ron & DeMarzo, Peter, 2021. "Contracting in Peer Networks," CEPR Discussion Papers 16177, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:16177
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    JEL classification:

    • D85 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Network Formation
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G3 - Financial Economics - - Corporate Finance and Governance
    • G4 - Financial Economics - - Behavioral Finance
    • J3 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs

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