Optimal Incentive Contracts Under Inequity Aversion

Englmaier, Florian; Wambach, Achim

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Optimal Incentive Contracts Under Inequity Aversion

IZA Discussion Paper No. 1643

47 Pages Posted: 18 Jul 2005 Last revised: 7 May 2025

See all articles by Florian Englmaier

Florian Englmaier

Ludwig Maximilian University of Munich (LMU) - Faculty of Economics

Achim Wambach

ZEW – Leibniz Centre for European Economic Research; University of Mannheim; CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

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: inequity aversion, sufficient statistics result, incentives, linear contracts, contract theory, incomplete contracts

JEL Classification: D23, D63, J31, J33, M12, Z13

Suggested Citation: Suggested Citation

Englmaier, Florian and Wambach, Achim, Optimal Incentive Contracts Under Inequity Aversion. IZA Discussion Paper No. 1643, Available at SSRN: https://ssrn.com/abstract=756409