Effects of Social Comparison on Incentive Contracts and Performance Evaluation

Abstract

Humans are known to gain or lose utility by comparing their payoffs with those of their peers. I analyze how such social preferences affect incentive contracts and performance evaluation in principal-agent settings. In my models, agents dislike getting worse off than their peers (I say they have a sense of ‘envy’). In some cases, I also assume agents either like or dislike getting better off than their peers (I say they have a sense of either ‘greed’ or ‘guilt’). This dissertation analyzes three different settings. In each setting, a principal hires two agents who work on productive tasks. First, I examine how joint-production settings are affected by social preferences. I show that the principal is indifferent about how envious the agents are, but she prefers guilty agents to greedy ones. Second, I show that envious agents can be efficiently incentivized by aggregated performance evaluation. This result supports the use of fixed-wage contracts and inflated ratings. Third, I analyze a situation in which an older agent is envious of his younger peer, but not vice versa. I show that (i) the optimal contract is characterized by pay inversion, granting a higher expected wage to the young agent than to the old agent, and (ii) the principal is worse off with unilaterally envious agents than bilaterally envious ones. The former result shows a benefit of causing pay inversion. The latter shows a cost of age diversity.