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High Compensation Creates a Ratchet Effect

Author

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  • Gersbach, Hans

    (ETH Zurich)

  • Glazer, Amihai

    (University of California, Irvine)

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.

Suggested Citation

  • Gersbach, Hans & Glazer, Amihai, 2004. "High Compensation Creates a Ratchet Effect," IZA Discussion Papers 1143, Institute of Labor Economics (IZA).
    • Handle: RePEc:iza:izadps:dp1143
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    Cited by:

    1. Hans Gersbach & Amihai Glazer, 2009. "High Compensation Creates a Ratchet Effect," Economic Journal, Royal Economic Society, vol. 119(539), pages 1208-1224, July.
    2. Kimiko Terai & Amihai Glazer, 2021. "How an ineffective agent can increase his budget," Economics and Politics, Wiley Blackwell, vol. 33(1), pages 133-147, March.

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    More about this item

    Keywords

    wealth effects; Ratchet effects; moral hazard; compensation; principal-agent; high-powered incentives;
    All these keywords.

    JEL classification:

    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • J30 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - General
    • J60 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - General

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