Incentives, Wages, and Promotions: Theory and Evidence¤

Human capital theory and agency theory are two of the most important building blocks of labor economics. However, the connection between these two building blocks has never been explicitly analyzed. This paper demonstrates that a simple moral hazard model, based on the premise that an agent’s e¤ort has a persistent e¤ect on future productivity through human capital accumulation, generates rich implications that solve numerous puzzling aspects of the observed internal wage and incentive structures within ...rms. This paper also presents an empirical analysis using new personnel records. JEL CLASSIFICATION: D82, J41, J31 ¤This paper is based on the ...rst part of my Ph.D. dissertation. Special thanks to Eric Maskin and Zvi Griliches for guidance and encouragement. Zvi Griliches also kindly shared the dataset with me. I would like to thank Lawrence Katz and Catherine Wolfram for many invaluable comments and suggestions. I am grateful to Phillippe Aghion, Richard Caves, Drew Fudenberg, Seki Obata, John Sutton, and participants of numerous seminars for useful comments and discussions. I also wish to thank Michael Whinston for helpful comments at early stages of this project. Financial support from the Korean Foundation for Advanced Studies is gratefully acknowledged. All remaining errors are my own.