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Journal of Law, Economics, and Organization Advance Access published online on December 6, 2007
Journal of Law, Economics, and Organization, doi:10.1093/jleo/ewm055
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© The Author 2007. Published by Oxford University Press on behalf of Yale University. All rights reserved. For permissions, please email: journals.permissions@oxfordjournals.org

Incentives in Markets, Firms, and Governments

Daron Acemoglu*

Massachusetts Institute of Technology

Michael Kremer**

Harvard University

Atif Mian***

University of Chicago

* Department of Economics, Massachusetts Institute of Technology. Email: daron{at}mit.edu.

** Department of Economics, Harvard University. Email: mkremer{at}fas.havard.edu.

*** Graduate School of Business, University of Chicago. Email: atif{at}chicagogsb.edu.

We construct a simple career concerns model where high-powered incentives can distort the composition of effort by inducing excessive signaling. We show that in the presence of this type of career concerns, markets typically fail to limit competitive pressures and cannot commit to the desirable low-powered incentives. Firms may be able to weaken incentives and improve efficiency by obscuring information about individual workers' contribution to output, and thus reducing their willingness to signal through a moral-hazard-in-teams reasoning. However, firms themselves have a commitment problem, since firm owners would like to provide high-powered incentives to their employees to increase profits. When firms cannot refrain from doing so, government provision may be useful as a credible commitment to low-powered incentives. Governments may be able to achieve this even when operated by a self-interested politician. Among other reasons, this may happen because of the government's ability to limit yardstick competition and reelection uncertainty. We discuss possible applications of our theory to pervasive government involvement in predominantly private goods such as education and management of pension funds.


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