This paper describes an organizational setting in which professional employees are required to work inefficiently long hours. The focus of the authors' investigation is large law firms. The income sharing that characterizes legal partnerships creates incentives to promote associates who have a propensity to work very hard. Law firms use indicators of this propensity--especially an associate's record of billable hours--in promotion decisions. Reliance upon work hours as an indicator leads to a rat-race equilibrium in which associates work too many hours. The authors find evidence in support of this conclusion with data they collected from two large law firms.

We analyze the effect of search frictions in the market for commercial health insurance. Frictions increase insurance premiums (enough to transfer 13.2 percent of consumer surplus from fully insured employer groups to insurers—approximately $34.4 billion in 1997); and increase insurance turnover (by 64 percent for the average policy). This rent transfer harms consumers and—when combined with heightened turnover—reduces incentives to invest in future health. We also find that a publicly financed insurance option can improve the efficiency of private insurance markets by reducing search friction induced distortions in pricing and marketing efforts.

Economic models of incentives in employment relationships are based on a specific theory of motivation: employees are “rational cheaters,” who anticipate the consequences of their actions and shirk when the marginal benefits exceed costs. We investigate the “rational cheater model” by observing how experimentally induced variation in monitoring of telephone call center employees influences opportunism. A significant fraction of employees behave as the “rational cheater model” predicts. A substantial proportion of employees, however, do not respond to manipulations in the monitoring rate. This heterogeneity is related to variation in employee assessments of their general treatment by the employer.