Minimum Payments, Incentives, and Markets∗

We consider the effect of an increase in the minimum feasible payment (driven by a minimum wage, limited liability, social norms or a legal restriction that pay cannot be negative) in markets with performance pay. We build a model in which a principal can adjust both the incentives of agents and the number of agents it employs. While a principal with a fixed number of agents will typically reduce the amount of effort it chooses to implement when the minimum payment increases, a principal that can also adjust its employment level will often instead increase the effort it induces. When embedded in a simple market setting, a typical outcome is that a moderate minimum payment makes all participants in the economy, including agents who keep their job, worse off. On the other hand, a considerable minimum payment, one that makes the issue of employee retention irrelevant, can help agents who keep their jobs.