ON THE EFFICIENCY OF THE RANK-ORDER CONTRACT UNDER MORAL HAZARD AND ADVERSE SELECTION

This article analyzes the efficiency of the rank-order contract for a finite number of risk-neutral agents under both moral hazard and adver se selection. The first-best outcome is shown to be supported by a set of rank-order contracts which penalize a small fraction of agents but do so heavily. The article also shows how these rank-order contracts compare with these giving a large prize to few agents. Finally, the ar ticle provides an informal argument for why firms do not follow a pena lty-giving rank-order contract in their promotion policies as often as the theory predicts.