Faculty of Economics and Business Administration Publications Database

Contractual Distortions in a Market with Frictions

Volume: 116
Number: 1
Pages: 155 - 176
Month: May
ISSN-Print: 0022-0531
Link External Source: Online Version
Year: 2004
Keywords: Screening; Contract design; Countervailing incentives
Abstract: This paper analyses contract design in a decentralized market environment with frictions. While principals (e.g., firms) have all contractual power, their market power is constrained as agents (e.g., workers) can choose to wait and search for better offers. We find that results depend crucially on how marketfrictions affect agents’ utilities. With type-independent costs of search and waiting, equilibrium contracts are always first-best. If agents are impatient and discount future payoffs, however, distortions vanish only gradually. In the latter case, we also characterize equilibrium offers and show that the market exhibits two types of externalities, both of which are absent in the case of type-independent costs of search.