Department of Economics. University of Melbourne. Melbourne Victoria 3010 Australia

ABSTRACT

In an ongoing organization, such as a large law parternship firm, employees are motivated not only by current rewards but also by the prospect of promotion, and the opportunity to influence policy and make the rules in the future. This leads to a dynamic programming problem in contract design.

We model career design in such a firm as a recursive mechanism design problem in an overlapping generations environment. Agents entering the firm may differ in their private characteristics which affect their costs of effort. We find that under recursive structure, a profit-maximising principal offers, and promotion-motivated agents accept, "rat-race" contracts with very low wages and high effort levels. With wages driven down to zero, promotions become the main instrument to discriminate among agents in an adverse selection environment. The optimal adverse selection contract introduces a promotion barrier, or a "glass ceiling", for the high cost agents. We thus find that the issues of inefficiently high work levels (the "rat-race") and of unequal promotion rates (the "glass ceiling") are intimately interconnected. We apply this framework to equal opportunity and gender discrimination in employment.