DP16177 Contracting in Peer Networks

Author(s): Peter DeMarzo, Ron Kaniel
Publication Date: May 2021
Programme Areas: Financial Economics, Organizational Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=16177

We consider multi-agent multi-firm contracting when agents benchmark their wages to their peers', using weights that vary within and across firms. When a single principal commits to a public contract, optimal contracts hedge relative wage risk without sacrificing efficiency. But compensation benchmarking undoes performance benchmarking, causing wages to load positively on peer output, and asymmetries in peer effects can be exploited to enhance profits. With multiple principals a "rat race" emerges: agents are more productive, with effort that can exceed the first-best, but higher wages reduce profits and undermine efficiency. Wage transparency and disclosure requirements exacerbate these effects.