Incentive Effects of Peer Pressure in Organizations

This paper studies the effects of peer pressure on incentives. We assume that, in addition to the material payoff, each agent's utility includes the psychological payoff from peer pressure generated by a comparison of effort costs. We show that the optimal incentive schemes depend mainly on the degree of peer pressure and of the heterogeneity of agents. Furthermore, we examine the optimal organizational forms in terms of the principal''s intention to make use of the effects of peer pressure.