Bonus Culture: Competitive Pay, Screening, and Multitasking

Bénabou, Roland; Tirole, Jean

doi:10.2139/ssrn.2460951

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Bonus Culture: Competitive Pay, Screening, and Multitasking

Princeton University William S. Dietrich II Economic Theory Center Research Paper No. 066_2014

59 Pages Posted: 5 Jul 2014

See all articles by Roland Bénabou

Roland Bénabou

Princeton University - Department of Economics; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); IZA Institute of Labor Economics

University of Toulouse 1 - Industrial Economic Institute (IDEI); University of Toulouse 1 - Groupe de Recherche en Economie Mathématique et Quantitative (GREMAQ); Centre for Economic Policy Research (CEPR)

There are 4 versions of this paper

Date Written: May 1, 2014

Abstract

This paper analyzes the impact of labor market competition on the structure of compensation. The model combines multitasking and screening, embedded into a Hotelling-like framework. Competition for the most talented workers leads to an escalating reliance on performance pay and other high-powered incentives, thereby shifting effort away from less easily contractible tasks such as long-term investments, risk management and within-firm cooperation. Under perfect competition, the resulting efficiency loss can be much larger than that imposed by a single firm or principal, who distorts incentives downward in order to extract rents. More generally, as declining market frictions lead employers to compete more aggressively, the monopsonistic underincentivization of low-skill agents first decreases, then gives way to a growing overincentivization of high-skill ones. Aggregate welfare is thus hill-shaped with respect to the competitiveness of the labor market, while inequality in earnings and utility tends to rise monotonically. Bonus caps and income taxes can help restore balance in agents' incentives and behavior, but may generate their own set of distortions.

Keywords: incentives, performance pay, bonuses, executive compensation, inequality, multitask contracts, screening, adverse selection, moral hazard, work ethic, Hotelling, competition

JEL Classification: D31, D82, D86, J31, J33, L13, M12

Suggested Citation: Suggested Citation

Bénabou, Roland and Tirole, Jean, Bonus Culture: Competitive Pay, Screening, and Multitasking (May 1, 2014). Princeton University William S. Dietrich II Economic Theory Center Research Paper No. 066_2014, Available at SSRN: https://ssrn.com/abstract=2460951 or http://dx.doi.org/10.2139/ssrn.2460951