Contracting in Peer Networks / Peter M. DeMarzo, Ron Kaniel.

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DeMarzo, Peter M

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Material type: Text

TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w28378.Publication details: Cambridge, Mass. National Bureau of Economic Research 2021.Description: 1 online resource: illustrations (black and white)Subject(s):

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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.

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Item type	Home library	Collection	Call number	Status	Date due	Barcode	Item holds
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Previous	nber w28375 Labor Market Institutions and the Distribution of Wages: The Role of Spillover Effects /	nber w28376 Information Avoidance and Image Concerns /	nber w28377 Liquidity, Pledgeability, and the Nature of Lending /	nber w28378 Contracting in Peer Networks /	nber w28379 The Organization of Innovation: Property Rights and the Outsourcing Decision /	nber w2838 The Case Against Trying to Stabilize the Dollar /	nber w28380 A Second-best Argument for Low Optimal Tariffs /	Next

January 2021.

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.