This article develops a new rationale for the emergence of pay-for-performance contracts where the labor market is competitive, workers are risk averse, and firms are risk neutral and unaware of workers' productivities. The article shows that the prevalence of pay for performance rises and the...

This paper develops a new rationale for the emergence of pay-for-performance contracts. The labor market is competitive, workers are risk averse and firms risk neutral. The paper shows that in stable environments more productive workers self-select into pay-for-performance jobs because risk is...