Team Incentives and Reference‐Dependent Preferences

Abstract

We investigate a multi-agent moral-hazard model where agents have expectation-based referencedependent preferencesà la Rabin (2006, 2007). We show that even when each agent's probability of success in a project is independent, a principal may employ team incentives. Because the agents are loss averse, they have first-order risk aversion to wage uncertainty. This causes the agents to work harder when their own failure is stochastically compensated through other agents' performance. In the optimal contract, agents with high performance are always rewarded, whereas agents with low performance are rewarded if and only if other agents' performance is high.

Desert and inequity aversion in teams

“…Applied to our team production setting, and if the agents differed in their cost of effort functions, the 'libertarian' notion would thus suggest that whether an agent deserves more than another should depend on relative efforts, while the 'liberal egalitarian' notion would suggest that desert should depend instead on relative costs of effort. 6 Daido and Murooka (2011) show that when workers are loss averse around choiceacclimating expectations, a principal might choose to use a 'team' contract under which one worker's pay increases in the performance of another in order to mitigate wage uncertainty. 7 An exception is Konow (2000), who considers only the optimal division of output by a dictator for given effort choices.…”

Factory benefits to paying workers more: The critical role of compensation systems in apparel manufacturing

“…Workers, on the other hand, regulate their behavior in order to optimize between wages received and effort exerted [35,36]. Individuals are not simply motivated by ever higher wages; they have a "reference" wage determined by their marginal utility of income [37][38][39]. Assuming no significant change in preferences, this is essentially the wage workers would be satisfied by.…”

Diasporas and Outsourcing: Evidence from oDesk and India

“…In a series of influential papers, Kőszegi and Rabin (2006, 2009) developed a model of reference-dependent preferences and loss aversion where "gain-loss utility" is derived from standard "consumption utility," and the reference point is determined endogenously by rational expectations. Their model has found many fruitful applications in different areas of economics, finance, and decision analysis, including firms' pricing and advertising strategies Kőszegi 2008, 2014;Spiegler 2012;Herweg and Mierendorff 2013;Peitz 2014, 2017;Rosato 2016;Karle and Schumacher 2017), incentives provision (Herweg et al 2010, Eliaz and Spiegler 2015, Daido and Murooka, 2016, Macera 2018, tournaments and contests (Gill and Stone 2010, Gül Mermer 2017, Dato et al 2018, Fu et al 2019, asset pricing (Pagel 2016), life cycle consumption (Pagel 2017), and bilateral negotiations (Benkert 2017, Rosato 2017, Herweg et al 2018). In particular, there have been several studies on the implications of expectations-based loss aversion Balzer and Rosato: Expectations-Based Loss Aversion in Auctions Management Science, Articles in Advance, pp.…”