Optimal Group Incentives with Social Preferences and Self-Selection

Abstract

In this paper, we analyze group incentives when a proportion of agents feel in- equity aversion as de…ned by Fehr and Schmidt (1999). We de…ne a separating equilibrium that explains the co-existence of multiple payment schemes in …rms. We show that a tournament provides strong incentives to agents who only care about their own payobut that it is not e¢ cient when agents are inequity averse. In fact, inequity averse agents are attracted by a revenue-sharing scheme in which the joint production is equally distributed, under the constraint that sel…sh agents have no incentive to join the revenue sharing organization. If the market is perfectly ‡exi- ble, this separating equilibrium induces a high eort level for both types of agents. Pareto gains are achieved by oering organizational choice to agents and the optimal contract is thus to propose both payment schemes to agents and to allow them to self-select into the dierent payment schemes.