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Pooling, Separating, and Cream-Skimming In Relative-Performance Contracts

By Yanguo Wang and Edward C. Jaenicke

Abstract

Existing research on tournament-style contests suggests that mechanisms to sort contestants by ability level are unnecessary in the case of linear relative-performance contracts. This paper suggests that this result stems from uniform treatment of workers' marginal returns from effort, marginal disutilities of effort, and reservation wages. Here, we investigate relative-performance contracts with a model that allows these three factors to vary by growers' unobservable ability. Given this framework, we find that it is possible for processors to improve expected profits and total expected welfare by replacing a single contract offering meant to pool all growers with an offering of two contracts meant to separate growers by ability. Under some circumstances, a "cream-skimming" contract offering designed to attract only workers above a minimum ability level can also improve expected profits.Production Economics,

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