IZA DP No. 163: Why Do Firms Pay an Overtime Premium?
This paper develops a two-period specific human capital model in which the bargaining parties seek to achieve optimal wage-hours contracts in the face of asymmetrically held information. With a single wage rate, we show that the problem of inefficient separations is so severe that, effectively, no specific training would take place. A wage premium on weekly overtime hours serves to reduce the effects of asymmetric information although it does not completely eliminate inefficiency. For those weekly hours for which a premium is paid, worker compensation exceeds the value of marginal product. There is an optimal automatic compensatory differential rule represented by an inverse relationship between the contractual wage and the overtime premium. Implications of imposing mandatory rules for premium pay and hours of work, as practiced in the United States, are assessed. The model is found to offer insights into important earlier finding in the literature.