What Drives Reciprocal Behavior? The Optimal Provision of Incentives Over the Course of Careers

Abstract

We explore how inherent preferences for reciprocity and repeated interaction interact in an optimal incentive system. Developing a theoretical model of a long-term employment relationship, we first show that reciprocal preferences are more important when an employee is close to retirement. At earlier stages, repeated interaction is more important because more future rents can be used to provide incentives. Preferences for reciprocity still affect the structure of an employment relationship early on, though, because of two reasons: first, preferences for reciprocity effectively reduce the employee’s effort costs. Second, they allow to relax the enforceability constraint that determines the principal’s commitment in the repeated interaction. Therefore, reciprocity-based and repeated-game incentives are dynamic substitutes, but complements at any given point in time. We test our main predictions using data from the German Socio-Economic Panel (SOEP) and find evidence for a stronger positive effect of positive reciprocity on effort for older workers.