A Model of Efficiency Wages as a Signal of Firm Value.

We consider performance contracts with firm private information. The verifiable components of the contract, an up-front wage and employment, may serve both as a signal and a performance incentive. Job rent may be necessary for signaling and, since efficient signaling is multidimensional, there is an inextricable link between job rent and underemployment. Signaling can explain the lack of explicit bonding in actuality. Though our basic model is static, our underemployment result is not a consequence of firm myopia. When the firm is farsighted, it will not maximize the joint future surplus if it cannot extract the worker's share at present. Copyright 1993 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.