Optimal Contracts for Ambitious Team Workers

30 Pages Posted: 23 Nov 2005

See all articles by Kong-Pin Chen

Kong-Pin Chen

Academia Sinica - Research Center for Humanities and Social Sciences; National Taiwan University - Department of Economics

Tsung-Sheng Tsai

National Taiwan University - Department of Economics

Date Written: November 13, 2005

Abstract

This paper invesigates the optimal compensation scheme for workers in a team who value not only absolute but also relative incomes. A worker is said to be more ambitious if his utility places more weight on relative income. In this case the firm can exploit the worker's preference for relative comparison to design a compensation scheme that induces the same effort level with lower cost. Under the optimal compensation scheme, the workers' wages are shown to depend on relative performance, and exhibit wage compression. More importantly, even if the production technology calls for absolute performance evaluation in the traditional principal-agent framework, the optimal wage structure still relies on relative performance. Finally, in contrast to past literature, worker heterogeneity is shown to reduce the firm's profit.

Keywords: relative performance, absolute performance, promotion tournament, wage contract, relative income comparison

JEL Classification: D2, D8, J3, L2

Suggested Citation

Chen, Kong-Pin and Tsai, Tsung-Sheng, Optimal Contracts for Ambitious Team Workers (November 13, 2005). Available at SSRN: https://ssrn.com/abstract=853784 or http://dx.doi.org/10.2139/ssrn.853784

Kong-Pin Chen (Contact Author)

Academia Sinica - Research Center for Humanities and Social Sciences ( email )

RCHSS
Academia Sinica
Nankang, Taipei, 11529
Taiwan
886 2 2789 8160 (Phone)
886 2 2785 4160 (Fax)

HOME PAGE: http://idv.sinica.edu.tw/kongpin/

National Taiwan University - Department of Economics

21 Hsiu Chow Rd
Taipei, 10020
Taiwan

Tsung-Sheng Tsai

National Taiwan University - Department of Economics ( email )

No. 1, Sec. 4, Roosevelt Rd.
Taipei, 10617
Taiwan

HOME PAGE: http://homepage.ntu.edu.tw/~tstsai

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