I analyze a model of production in a competitive environment with heterogeneous …rms. E ¢ cient production requires individuals within the organization to take noncontractible actions for which rewards must be informally promised rather than contractually assured. The credibility of such promises emerges from a …rm’s future competitive rents. Equilibrium competitive rents are ine ¢ ciently concentrated at the top. I explore several policy and empirical implications of this result. (JEL D21, D24, L14, L22)

This paper provides evidence that involuntary unemployment, and the segmentation of labor markets into firms offering “good ” and “bad ” jobs, may both arise as a con-sequence of contractual incompleteness. We provide a simple model that illustrates how unemployment and market segmentation may jointly emerge as part of a market equilibrium in environments where work effort is not third-party verifiable. Using ex-perimental labor markets that differ only in the verifiability of effort, we demonstrate empirically that contractual incompleteness can cause unemployment and segmenta-tion. Our data are also consistent with the key channels through which the model explains the emergence of both phenomena.