Incentive Contracts, Social Comparison and Organizational Design

Abstract: The role of organization structure has been of great interest to stakeholders interested in boosting firm productivity and profits. As organizational architecture affects the level of interaction among workers, who often realize heterogenous compensation for their effort, different processes of social comparison are likely to emerge under varying structures. This paper contributes to a nascent literature on these processes, investigating how firms' organizational choices are influenced by envy. It considers a principal-two agent model where ex-ante identical agents either work jointly in a single unit, or separately in different units of a firm. It is posited that envy arises only in the first case, and the paper derives the optimal organizational form depending on technology complementarity, envy, and financial constraints on the agents' side. It identifies conditions under which there is always a Nash equilibrium of the effort choice among the agents under joint production. The findings of the model are that while joint production can take advantage of technological complementarities, with unlimited liability, this advantage decreases with envy. When liability is limited, however, the envy effect moves in opposite direction and therefore with complementarity factor increase agents' effort level, such that joint production is always preferable for the principal. Furthermore, the paper shows that individual bonus schemes outperform group bonus schemes as long as rent is earned.