NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Competition and the Ratchet Effect

Gary Charness, Peter Kuhn, Marie-Claire Villeval

NBER Working Paper No. 16325
Issued in September 2010
NBER Program(s):   LS

In labor markets, the ratchet effect refers to a situation where workers subject to performance pay choose to restrict their output, because they rationally anticipate that firms will respond to higher output levels by raising output requirements or cutting pay. We model this effect as a multi-period principal-agent problem with hidden information, and study its robustness to labor market competition both theoretically and experimentally. Consistent with our theoretical model, we observe substantial ratchet effects in the absence of competition, which is nearly eliminated when competition is introduced; this is true regardless of whether market conditions favor firms or workers.

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Published: Gary Charness & Peter Kuhn & Marie Claire Villeval, 2011. "Competition and the Ratchet Effect," Journal of Labor Economics, University of Chicago Press, vol. 29(3), pages 513 - 547.

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