Sherwin Rosen

Rank-Order Tournaments as Optimum Labor Contracts

This paper analyzes compensation schemes which pay according to an individuals ordinal rank in an organization rather than his output level. When workers are risk neutral, it is shown that wages based upon rank induce the same efficient allocation of resources as an incentive reward scheme based on individual output levels. Under some circumstances, risk-averse workers actually prefer to be paid on the basis of rank. In addition, if workers are heterogeneous in ability, low-quality workers attempt to contaminate high-quality firms, resulting in adverse selection. However, if ability is known in advance, a competitive handicapping structure exists which allows all workers to compete efficiently in the same organization.

Authority, Control, and the Distribution of Earnings

The distributions of firm size, span of control, and managerial incomes are modeled as the joint outcome of market assignments of personnel to hierarchical positions. Assigning persons of superior talent to top positions increases productivity by more than the increments of their abilities because greater talent filters through the entire firm by a recursive chain of command technology. These multiplicative effects support enormous rewards for top level management in large organizations. Also, superior managers control more than proportionately larger firms. Consequently, the distributions of reward and firm size are skewed relative to the distribution of abilities.

Chapter 12 The theory of equalizing differences

The chapter presents a discussion on the theory of equalizing differences. The theory of equalizing differences refers to observed wage differentials required to equalize the total monetary and nonmonetary advantages or disadvantages among work activities and among workers themselves. On the conceptual level, it can make legitimate claim to be the fundamental (long-run) market equilibrium construct in labor economics. Its empirical importance lies in contributing useful understanding to the determinants of the structure of wages in the economy and for making inferences about preferences and technology from observed wage data. Measurable job attributes on which compensating wage differentials have been shown to arise empirically include (1) onerous working conditions, such as risks to life and health, exposure to pollution, and so forth; (2) intercity and interregional wage differences associated with differences in climate, crime, pollution, and crowding; (3) special work-time scheduling and related requirements, including shift work, inflexible work schedules, and possible risks of layoff and subsequent unemployment; and (4) the composition of pay packages, including vacations, pensions, and other fringe benefits as substitutes for direct cash wage payments. Another important class of problems identifies work environments with investment rather than with consumption. Market equilibrium is defined by equality between demand and supply for workers on each type of job.

Housing Investment in the United States

A supply-determined model of housing investment is estimated from quarterly data over the 1963-83 period. The model is built on dynamic marginal cost pricing considerations and allows short- and long-run supply elasticities to differ. These are estimated as 1.0 and 3.0, respectively, but most of the long-run response occurs within 1 year. Rapid adjustment speed and the sizable long-run elasticity of supply are important factors in understanding the volatility of housing investment. The data also suggest some anomalies in the expected present value theory of asset pricing for housing capital.

The value of changes in life expectancy

Valuation formulas for age-specific mortality risks are derived from life-cycle allocation theory under uncertainty and related to empirical estimates of the value of life. A change in an age-specific mortality risk affects all subsequent survivor functions and reallocates consumption and labor supply over the entire life cycle. The value of eliminating a risk to life at a specific age is the expected present value of consumer surplus from that age forward. Approximate numerical extrapolations from cross-section estimates imply that values decrease rapidly in current age and in the distance between current age and age at risk.

Specialization and Human Capital

Incentives for specialization, trade, and the production of comparative advantage through investment are shown to arise from increasing returns to utilization of human capital. Indivisibilities imply fixed-cost elements of investment that are independent of subsequent utilization. Hence the rate of return is increasing in utilization and is maximized by utilizing specialized skills as intensively as possible. Identically endowed individuals have incentives to specialize their investments in skills and trade with each other for this reason, even if production technology exhibits constant returns to scale.

Learning by Experience as Joint Production

I. Introduction, 366. — II. The optimal rate of learning, 368. — III. Modifications and extensions, 376. — IV. Discussion and application of the model, 377.

Labour Markets in Professional Sports

Many interesting elements of supply and demand are starkly observable in professional athletics. Understanding institutional arrangements, competitive balance and labor-management relations requires a basic understanding of sports labor markets and the struggle for control of those markets between interest groups. In this paper we treat historical and contemporary labor issues in North America and Europe, from reserve rules and free agency, high levels of player pay and work stoppages, to the distribution of playing talents across teams. We discuss the relationship between personal productivity and pay; relative versus absolute demand; competitive and cooperative interactions across firms (teams); factor substitutions; player mobility and the Coase theorem. We briefly consider how property rights affect supply, athletic talent, arms races and restrictions on competition. The problem of (excess) incentives to compete leading to externalities and inefficiencies are noted throughout the paper. Restrictive agreements such as reverse-order drafts, payroll caps and revenue sharing may constrain these forces, but they also redistribute rents from players to owners. All of these schemes, in one way or another, punish success. The European approach -- promotion of better-performing teams and relegation of those with the poorest records -- punishes failure. It remains an interesting economic question as to which system is better.

THEORIES OF THE DISTRIBUTION OF EARNINGS

Several empirical regularities motivate most theories of the distribution of labor earnings. Earnings distributions tend to be skewed to the right and display long right tails. Mean earnings always exceed median earnings and the top percentiles of earners account for quite a disproportionate share of total earnings. Mean earnings also differ greatly across groups defined by occupation, education, experience, and other observed traits. With respect to the evolution of the distribution of earnings for a given cohort, initial earnings dispersion is smaller than the dispersion observed in prime working years.We explore several models that address these stylized facts. Stochastic theories examine links between assumptions about the distribution of endowments and implied features of earnings distributions given assumptions about the processes that translate endowments into earnings. Selection models describe how workers choose a career. Because workers select their best option from a menu of possible careers, their allocation decisions tend to generate skewed earnings distributions. Sorting models illustrate this process in an environment where workers learn about their endowments and therefore adjust their allocation decisions over time.Human capital theory demonstrates that earnings dispersion is a prerequisite for significant skill investments. Without earnings dispersion, workers would not willingly make the investments necessary for high-skill jobs. Human capital models illustrate how endowments of wealth and talent influence the investment decisions that generate observed distributions of earnings.Agency models illustrate how wage structures may determine rather than reflect worker productivity. Tournament theory addresses the long right tails of wage distributions within firms. Efficiency wage models address differences in wages across employments that involve different monitoring technologies.

Substitution and Division of Labour

AbstractThe following sections are included:IntroductionIndirect Production FunctionsSelection and Income DistributionConclusionAcknowledgmentsReferences