Individual vs. Relative Performance Pay with Envious Workers and Non-Verifiable Performance

Abstract:     
In a moral-hazard environment, I compare the profitabilities of a rank-order tournament and independent bonus contracts when a firm employs two envious workers whose individual performances are not verifiable. Whereas the bonus scheme must then be self-enforcing, the tournament is contractible. Yet the former incentive regime outperforms the latter as long as credibility problems are not too severe. This is due the fact that the tournament requires unequal pay across peers with certainty, thereby imposing large inequity premium costs on the firm. For a simple example, I show that the more envious the agents are, the larger is the range of interest rates for which the bonus scheme dominates the tournament.

Number of Pages in PDF File: 43

Keywords: principal-agent, relational contract, inequity aversion, bonus, tournament, prize, team, envy

JEL Classification: D63, D82, M52, M54

working papers series