Asymmetric Information and Labor Contracts: A Survey

This paper surveys models of optimal labor contracts between risk averse workers and privately informed firms. We analyze the inefficiencies resulting from the conflict between the provision of incentives for the firm and risk sharing considerations. We show that limitations on the firms (or its managers) ability to absorb risk move the second-best contract outcome toward underemployment, while an income effect on the workers demand for leisure is a force toward overemployment. The survey concludes by discussing models of the aggregate consequences of labor allocation through contracts constrained by asymmetric information.