Robust Contract with Career Concerns

TL;DR

This paper explores how non-additive monitoring technology and strategic uncertainty influence employment contracts, leading to private wage discrimination and within-group pay inequality driven by skill-effort complementarity.

Contribution

It identifies a necessary and sufficient condition for strategic uncertainty in contracts and shows how employers use private wage discrimination to mitigate pessimistic market expectations.

Findings

Multiple equilibria can arise due to interdependence of market expectations and efforts.

Employers create private wage discrimination to eliminate low effort and pessimistic expectations.

Within-group pay inequality is driven by contractual privacy and coordination motives.

Abstract

An employer contracts with a worker to incentivize efforts whose productivity depends on ability; the worker then enters a market that pays him contingent on ability evaluation. With non-additive monitoring technology, the interdependence between market expectations and worker efforts can lead to multiple equilibria (contrasting Holmstrom (1982/1999); Gibbons and Murphy (1992)). We identify a sufficient and necessary criterion for the employer to face such strategic uncertainty--one linked to skill-effort complementarity, a pervasive feature of labor markets. To fully implement work, the employer optimally creates private wage discrimination to iteratively eliminate pessimistic market expectations and low worker efforts. Our result suggests that present contractual privacy, employers' coordination motives generate within-group pay inequality. The comparative statics further explain several stylized facts about residual wage dispersion.