Work Incentives, Hierarchy, and Internal Labor Markets

Abstract

This paper argues that contracts with payment based on a ranking of employee performance can provide performance incentives even under asymmetric information that prevents payment based on individual performance only being enforceable. Such contracts also fit with five features of labor markets that have aroused considerable interest: (1) hierarchical wage structures; (2) internal promotion; (3) wage rates that rise with seniority and experience more than productivity; (4) the variance of earnings increasing with experience; and (5) wage rates attached to jobs rather than individuals with differentials set by administrative procedures rather than by reference to external market wages.