Principal-Agent Assignment: Implications for Incentives and Income Distribution in Tenancy Relationships

I analyze a problem of assigning heterogeneous agents (tenants) to heterogeneous principals (landlords), where partnerships are subject to moral hazard in effort choice. The agents differ in wealth endowment and the principals differ in land quality. When the liability of each agent is limited by his initial wealth, a share contract is typically incentive compatible. A pure rent contract, on the other hand, is optimal in the absence of incentive problems. In a Walrasian equilibrium of the economy, wealthier agents work in more productive lands following a positively assortative matching pattern since higher wealth has greater effect in high-productivity lands. Agent's share of the match output is in general non-monotone with respect to initial wealth. If wealth is more unequally distributed than land quality, then the equilibrium share (of the agents) is a monotonically increasing function of wealth. Under symmetric information, all agents earn the same expected wage, and hence no income inequality is observed in equilibrium. When incentive problems are important, wealthier agents earn higher wages, and the income inequality decreases if the agents are more heterogeneous than the principals.