Essays in contract and search theory

Starmans, J (2018) Essays in contract and search theory. Doctoral thesis, University of London: London Business School.

Abstract

The three chapters in my thesis study employee incentive compensation. While the contracting literature studies optimal incentive compensation, it largely bypasses the question of which agent a firm should hire in the first place. In the first chapter of my thesis, I develop a joint theory of incentive compensation and hiring decisions in a setting where different agents generate different probability distributions of output under effort, which capture differences in employee characteristics such as education and experience. I show how contractual frictions such as limited liability can bias hiring decisions. The results imply a novel link between incentives and hiring, which I further explore in the second and third chapter in the context of a frictional labor market. The second chapter develops a theory of contract and rent dispersion in a frictional labor market, and studies the implications of the incentive and compensation problem for a principal's search and hiring decisions. In the third chapter, I use these insights to build a theory of search unemployment with dispersion in incentive pay.