NONSTATIONARY RELATIONAL CONTRACTS WITH ADVERSE SELECTION

Authors

  • Huanxing Yang

    1. The Ohio State University, U.S.A.
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    • I am grateful to Jan Eeckhout, Dirk Krueger, Volker Nocke, George Mailath, Nicola Persico, Rafael Rob, Petra Todd, and especially to Steven Matthews and two anonymous referees for valuable comments. I also would like to thank the seminar participants at Iowa, OSU, LSE, and SMU for their useful comments. Please address correspondence to: Huanxing Yang, Department of Economics, The Ohio State University, 410 Arps Hall, 1945 N. High St., Columbus, OH 43210. E-mail: yang.1041@osu.edu.


  • Manuscript received October 2011; revised May 2012.

Abstract

I develop a model of nonstationary relational contracts in order to study internal wage dynamics. Workers are heterogeneous, and each worker’s ability is both private information and fixed for all time. Learning therefore occurs within employment relationships. The inferences, however, are confounded by moral hazard. Incentive provision is restricted by an inability to commit to long-term contracts. Relational contracts, which must be self-enforcing, must therefore be used. The wage dynamics in the optimal contract, which are pinned down by the tension between incentive provision and contractual enforcement, are intimately related to the learning effect.

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