Abstract
Chapter 1: Imposing caps on managers' pay has been a popular way to discipline managers of companies or banks that have got into trouble during the recent financial crisis. Using a small extension of the standard principal-agent model, we argue that pay caps will generally serve the opposite purpose because the agent is always better off with a pay cap. Specifically, we show that the agent's limited-liability rent increases as the pay cap become more stringent. The model also offers a characterization of the effect of pay caps on the general structure of optimal incentive contracts. While improvement of contracting information always helps the principal, it may increase or decrease the marginal cost of imposing pay caps. Chapter 2: This chapter aims to investigate how the value of employment relationships affects job security and career paths faced by employees. In a model of relational contracting with limited liability, we show that when the value of the relationship between a principal and an agent decreases, the agent is more vulnerable to job loss and faces the prospect of a longer and harder promotion ladder to climb, both of which reduce the agent's limited liability rent. In particular, when the value is sufficiently low, an additional promotion phase after tenured emerges.