Recursive contracts, firm longevity, and rat races: An experimental analysis

- We explore contract structures in overlapping-generation firms.
- Future ownership is a perquisite of employment.
- The old generation offers employment contracts to the young generation.
- We show that as firm longevity increases, rat races with rent dissipation emerge.
- The results have implications for long-lived firms such as partnerships.

This paper reports the results from a laboratory experiment which investigates the structure of contracts that emerge in overlapping-generation firms where future ownership is a perquisite of employment. Workers in the young generation are offered employment contracts designed by the firms' owners who belong to the old generation. When old, employed workers are granted ownership rights as long as the firm continues to operate. In line with theoretical predictions, the results indicate that as firm longevity increases, the recursive nature of the contracts leads to a rat race characterized by low wages, high effort levels, and rent dissipation. These results have important implications for the optimal management of long-lived firms such as partnerships.