Optimal Incentive Contracts when Workers envy their Boss

A worker's utility may increase with his income, but envy can make his utility decline with his employer's income. This article uses a principal-agent model to study profit-maximizing contracts when a worker envies his employer. Envy tightens the worker's participation constraint and so calls for higher pay and/or a softer effort requirement. Moreover, a firm with an envious worker can benefit from profit sharing, even when the worker's effort is fully contractible. We discuss several applications of our theoretical work: envy can explain why a lower-level worker is awarded stock options, why incentive pay is lower in nonprofit organizations, and how governmental production of a good can be cheaper than private production.<P>This discussion paper has resulted in a publication in the <A href="http://proquest.umi.com/pqdlink?index=8&did=1445798241&SrchMode=3&sid=1&Fmt=2&VInst=PROD&VType=PQD&RQT=309&VName=PQD&TS=1234345749&clientId=5072&aid=1&cfc=1"><I>Journal of Law, Economics and Organization</I></A>. (2008, 24(1), 120-138.)