HEC Research Papers Series,
HEC Paris

Abstract: We consider a model of endogenous occupational choice in economies with a continuum of individuals who differ in their endowments. Individuals have a choice of remaining self-employed or engaging in productive matches with another individual, i.e., forming firms. Matches are subject to a moral hazard problem with limited liability constraints. We suppose that the division of the gains from such matches is endogenous and determined by competitive market forces. We characterize the equilibrium matching patterns as a function of the nature (symmetry) of the underlying incentive problem within a firm. We give necessary and sufficient conditions for "segregation" (wealth-homogeneous firms) to occur in equilibrium. We show that the equilibrium distributions of occupations, utilities and surplus typically depend on the distribution of wealth in the economy, possibly in nonmonotonic ways. We study the "trickle down" effects of taxation. We show how financial markets imperfections or matching restrictions may restore segregation.

Keywords: matching; contract theory; club theory; firm formation; incomplete markets

JEL-codes: D20; D31; D50; D82

52 pages, January 1, 2001

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