Abstract
We analyze on-the-job search when moral hazard among employees calls for incentive schemes that include deferred compensation. While deferred compensation improves the workers’ incentives to exert effort, it distorts the workers’ on-the-job search decisions. We show that deferred compensation is less attractive when overall turnover in the market is high. Moreower, there exists feedback effects between the firms’ choice of wage contracts and the labor market tightness in the on-the-job search market. This may lead to multiple equilibria: a low-turnover equilibrium where firms use deferred compensation to motivate workers, and a high-turnover equilibrium where they do not. Our model provides an explanation for observed differences in turnover rates between countries, e.g. US and Europe or Japan, and between regions e.g. Silicon Valley and Route 128.