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Recursive Contracts

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  • Bardsley, P.

Abstract

We model career design as a recursive contract design problem in an overlapping generations firm. Agents live two periods. In period 1 they may be hired as employees, paid a wage, and produce output. In period 2 they may be promoted to become joint owners (partners) of the firm, producing no output directly, but setting the rules and receiving the residual income. Professional partnerships, such as the traditional law firm, are often organized like this. Employees are motivated not only by the wage but by the possibility of promotion to the partnership, and the opportunity to set the rules in the next period; the reward structure is thus recursive. The contracts that emerge in this environment are always inefficient. In many circumstances the inefficiency takes the form of “rat-race” contracts that specify very low wages and an inefficiently high level of effort. This conclusion seems to be robust to a range of variations in the environment.

Suggested Citation

  • Bardsley, P., 2001. "Recursive Contracts," Department of Economics - Working Papers Series 797, The University of Melbourne.
    • Handle: RePEc:mlb:wpaper:797
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    File URL: http://www.economics.unimelb.edu.au/downloads/wpapers-00-01/797.pdf
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    References listed on IDEAS

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    Cited by:

    1. Peter Bardsley & Katerina Sherstyuk, 2001. "Rat Races and Glass Ceilings- Career Paths in Organizations," Working Papers 200106, University of Hawaii at Manoa, Department of Economics.

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    More about this item

    Keywords

    recursive contracts; mechanism design; overlapping generations; rat-race;
    All these keywords.

    JEL classification:

    • K12 - Law and Economics - - Basic Areas of Law - - - Contract Law
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation

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