Uncertainty, Pay for Performance, and Asymmetric Information

This article develops a new rationale for the emergence of pay-for-performance contracts where the labor market is competitive, workers are risk averse, and firms are risk neutral and unaware of workers' productivities. The article shows that the prevalence of pay for performance rises and the pay-for-performance sensitivity falls as environmental uncertainty increases. This empirical regularity is unaccounted for alternative models such as the standard agency model. (JEL D86, L2, M5, J3) The Author 2008. Published by Oxford University Press on behalf of Yale University. All rights reserved. For permissions, please email: journals.permissions@oxfordjournals.org, Oxford University Press.