Why Wages Don’t Fall in Jobs with Incomplete Contracts

We investigate how the incompleteness of an employment contract—discretionary and noncontractible effort—can affect an employer’s decision about cutting nominal wages. Using matched employer-employee payroll data from Great Britain linked to a survey of managers, we find support for the main predictions of a stylized theoretical framework of wage determination: nominal cuts are at most half as likely when managers believe that their employees have significant discretion over how they do their work, although the involvement of employees, via information sharing, reduces this correlation. We also describe how contract incompleteness and wage cuts vary across different jobs. These findings provide the first observational quantitative evidence that managerial beliefs about contractual incompleteness can account for their hesitancy over nominal wage cuts. This has long been conjectured by economists based on anecdotes, qualitative surveys, and laboratory and field experiments. This paper was accepted by Marie Claire Villeval, behavioral economics and decision analysis. Funding: M. Fongoni acknowledges funding under the “France 2030” Investment Plan managed by the Agence Nationale de la Recherche [Grant ANR-17-EURE-0020] and funding from the Excellence Initiative of Aix-Marseille University—A*MIDEX. C. Singleton thanks the Economic and Social Research Council and Administrative Data Research UK [Grant ES/T013877/1] for funding the Wage and Employment Dynamics Project. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2023.02297 .