Effects of Pay Variability and Mutual Monitoring on Employee Effort and Contract Choice

Abstract

A primary cause of income volatility for employees is job loss due to firm downsizing. Economists have suggested that firms use share contracts rather than wage contracts as one possible solution to downsizing. In my experimental setting employment contracting involves an employer who hires two employees to produce output. In each of 31 rounds, employees choose between a wage contract (status quo) and a share contract with an employer-set sharing rule. I manipulate whether the share contract incorporates a form of mutual monitoring and examine the effects on employee effort, contract preference, and welfare. The results show that, compared to wage contracts, subjects exert more effort and have higher welfare when they choose share contracts. Incorporating mutual monitoring into the share contract also increases total effort and subject welfare but does not lead to an increase in the use of share contracts.