Robert Gibbons

Optimal Incentive Contracts in the Presence of Career Concerns: Theory and Evidence

This paper studies optimal incentive contracts when workers have career concerns--concerns about the effects of current performance on future compensation. We show that the optimal compensation contract optimizes total incentives: the combination of the implicit incentives from career concerns and the explicit incentives from the compensation contract. Thus the explicit incentives from the optimal compensation contract should be strongest for workers close to retirement because career concerns are weakest for these workers. We find empirical support for this prediction in the relation between chief executive compensation and stock market performance.

Learning and Wage Dynamics

We develop a dynamic model of learning and wage determination: education may convey initial information about ability, but subsequent performance observations also are informative. Although the role of schooling in the labor markets inference process declines as performance observations accumulate, the estimated effect of schooling on the level of wages is independent of labor-market experience. In addition: time-invariant variables correlated with ability but unobserved by employers are increasingly correlated with wages as experience increases; wage residuals are a martingale; and wage cuts -are not rare, even for workers who do not change jobs. We present evidence from the National Longitudinal Survey of Youth that is generally consistent with all four of the models predictions. We conclude that a blend of the learning model with an on-the-job-training model is more plausible than either model alone.

Four Formal(izable) Theories of the Firm

In this essay, I define and compare elemental versions of four theories of the firm. These elemental theories are distilled from important contributions by Hart, Holmstrom, Klein, Williamson, and others. Although these contributions have been widely cited and much discussed, I have found it difficult to understand the commonalities, distinctions, and potential combinations of these seemingly familiar contributions. In this essay, therefore, I attempt to clarify these issues in three steps: I begin with informal summaries of the theories, then turn to simple but formal statements of each elemental theory, and finally nest the four elemental theories in an integrative framework.

A Theory of Wage and Promotion Dynamics Inside Firms

We show that a framework that integrates job assignment, human-capital acquisition, and learning captures several empirical findings concerning wage and promotion dynamics inside firms, including the following. First, real-wage decreases are not rare but demotions are. Second, wage increases are serially correlated. Third, promotions are associated with large wage increases. Fourth, wage increases at promotion are small relative to the difference between average wages across levels of the job ladder. Fifth, workers who receive large wage increases early in their stay at one level of the job ladder are promoted quickly to the next.

Task-Specific Human Capital

Since Gary Becker’s (1964) seminal work, the theoretical and empirical literature on human capital has focused almost exclusively on general-purpose and firm-specific human capital. In this paper we discuss the implications of a third type of human capital, which we call task-specific, and which we believe is potentially as commonplace and as important as the two classic types. By task-specific human capital we mean that some of the human capital an individual acquires on the job is specific to the tasks being performed, as opposed to being specific to the firm. In other words, task-specific human capital is the simple but plausible idea that much of the human capital accumulated on the job is due to task-specific learning by doing. The idea of task-specific human capital is closely related to occupationand industryspecific human capital. In each case, human capital is specific to the nature of the work, not specific to the firm. Hence, when capital is accumulated, multiple firms value the capital, so most (or even all) of the value of the capital will be reflected in the worker’s wage. The main difference between the idea of task-specific human capital and occupationand industryspecific human capital is in how the idea is applied. We argue that task-specific human capital has much wider applicability than suggested (so far) by the occupationand industry-specific human-capital literatures; the specific issues we address are cohort effects, job design, and promotions. Another argument in the literature closely related to ours is the classic argument of Adam Smith (1776) in the Wealth of Nations concerning returns to specialization. Smith’s argument was that, due to learning-by-doing at the level of the task, productivity can be enhanced by having each job entail fewer tasks. We believe that Smith was correct in focusing on learningby-doing at the level of the task as an important idea for thinking about organizations. The goal of our paper is to describe some of the other implications of this idea for the design and operation of organizations.

The Handbook of Organizational Economics

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Simultaneous Signalling to the Capital and Product Markets

In this article we analyze an informed firms choice of financial structure when the financing contract is observed not only by the capital market but also by a second uninformed party, such as a competing firm. The informed firms gross profit is endogenous, because the second partys action depends on the transaction it observes between the informed firm and the capital market. The main result is that the reasonable capital-market equilibria maximize the ex ante expectation of the informed firms endogenous gross profits. In distinct contrast to earlier work, which focuses on separating equilibria, in our model it is often the case that all the reasonable equilibria are pooling.

Piece-Rate Incentive Schemes

This paper uses recent results from incentive theory to study heretofore informal critiques of piece-rate compensation schemes. The informal critiques are based on the history of failed attempts to install piece-rate compensation schemes at the turn of the century. The formal analysis emphasizes the importance of information and commitment in contracting. The main result is as follows. In a work environment characterized by hidden information and a hidden action, if neither the firm nor the worker can commit to future behavior, then no compensation scheme, piece-rate or otherwise, can induce the worker not to restrict output.

Relational Contracts and Organizational Capabilities

A large literature identifies unique organizational capabilities as a potent source of competitive advantage, yet our knowledge of why capabilities fail to diffuse more rapidly—particularly in situations in which competitors apparently have strong incentives to adopt them and a well-developed understanding of how they work—remains incomplete. In this paper we suggest that competitively significant capabilities often rest on managerial practices that in turn rely on relational contracts (i.e., informal agreements sustained by the shadow of the future). We argue that one of the reasons these practices may be difficult to copy is that effective relational contracts must solve the twin problems of credibility and clarity and that although credibility might, in principle, be instantly acquired, clarity may take time to develop and may interact with credibility in complex ways so that relational contracts may often be difficult to build.

Taking Coase Seriously

In this essay I advance two related theses. First, economic theory predicts that organizations will be a mess but not a mystery. Second, classic case studies conducted by organizational sociologists support this prediction. Fully articulating and defending these theses will require a book, so my goal here is simply to render them plausible. I begin by pointing toward the relevant economic theory and sociological evidence, but I devote the bulk of the essay to a particular example: I develop a formal economic model inspired by a passage from Michel Croziers The Bureaucratic Phenomenon. I conclude by discussing the potential roles of formal economic modeling in organizational research.