The Intensity of Incentives in Firms and Markets: Moral Hazard with Envious Agents

Bartling, Björn and Siemens, Ferdinand von (April 2006): The Intensity of Incentives in Firms and Markets: Moral Hazard with Envious Agents. SFB/TR 15 Discussion Paper No. 115

Abstract

While most market transactions are subject to strong incentives, transactions within Firms are often not incentivized. We offer an explanation for this observation based on envy among agents in an otherwise standard moral hazard model with multiple agents. Envious agents suffer if other agents receive a higher wage due to random shocks to their performance measures. The necessary compensation for expected envy renders incentive provision more expensive, which generates a tendency towards flat-wage contracts. Moreover, empirical evidence suggests that social comparisons like envy are more pronounced among employees within Firms than among individuals who interact only in the market. Flat-wage contracts are thus more likely to be optimal in Firms than in markets.

• Item Type: Paper
• Keywords: Envy, moral hazard, flat-wage contracts, within-Firm vs. market interactions
• Faculties: Special Research Fields > Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems; Special Research Fields > Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems > A4 - Unvollständige Verträge, Marktinteraktion und soziale Vergleichsprozesse
• Subjects: 300 Social sciences > 330 Economics
• JEL Classification: D82, J3, M5
• Language: English