Optimal Contracting with Reciprocal Agents
Description
(with Florian Englmaier) (Job Market Paper)
Abstract: Empirically, compensation systems often seem to generate substantial effort despite weak incentives. We consider reciprocal motivations as a source of incentives. We solve for the optimal contract in the basic principal-agent problem and show that reciprocal motivations and explicit performance-based pay are substitutes. A firm can endogenously determine which mix of the two sources of incentives it uses. Analyzing extended versions of the model allows us to examine how organizational structure impacts reciprocity and to derive quite specific empirical predictions. Using these predictions we conduct a real effort experiment to demonstrate the effects of reciprocity on the effectiveness of incentive systems. We also conduct a field experiment testing for reciprocity, and analyze the UK WERS workplace compensation data set.