Group vs. Individual Performance Pay in Relational Employment Contracts when Workers Are Envious

I compare group to individual performance pay when workers are envious and performance is non-verifiable. Avoiding payoff inequity, the group bonus contract is superior as long as the firm faces no credibility problem. The individual bonus contract may, however, become superior albeit introducing the prospect of unequal pay. This is due to two reasons: The group bonus scheme is subject to a free-rider problem requiring a higher incentive pay and impeding credibility of the firm. Moreover, with individual bonuses the firm benefits from the incentive-strengthening effect of envy, allowing for yet smaller incentive pay and further softening the credibility constraint