Effort observability and wage promotion in an internal labor market

Abstract

This paper discusses various aspects of optimal wage contracts in a hierarchical firm. Contracts of wage payment which we introduce are based not only on the amount of the realized revenue (or outputs) but also on a ranking of the observed effort of workers. The principal-agent problem has dealt with optimal incentive contracts where there is difficulty in observing agent’ effort due to the existence of a random factor unobservable to a firm.