Optimal Incentive Contracts Under Inequity Aversion
47 Pages Posted: 18 Jul 2005
Date Written: June 2005
Abstract
We analyze the Moral Hazard problem, assuming that agents are inequity averse. Our results differ from conventional contract theory and are more in line with empirical findings than standard results. We find: First, inequity aversion alters the structure of optimal contracts. Second, there is a strong tendency towards linear sharing rules. Third, it delivers a simple rationale for team based incentives in many environments. Fourth, the Sufficient Statistics Result is violated. Dependent on the environment, optimal contracts may be either overdetermined or incomplete.
Keywords: contract theory, linear contracts, incentives, sufficient statistics result, inequity aversion, incomplete contracts
JEL Classification: D23, D63, J31, J33, M12, Z13
Suggested Citation: Suggested Citation
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