We consider a firm which pays a worker for his effort over several periods. The more the firm
pays in one period, the wealthier the worker is in the following periods, and so the more he
must be paid for a given effort. This wealth effect can induce an employer to pay little initially
and more later on. For related reasons, the worker may work harder than the employer
prefers. The incentive contracts firms offer may therefore cap the worker’s earnings. Lastly,
this wealth ratchet effect can induce excessive firing and turnover.