2006, When the Talented Should Receive Weaker Incentives

We study optimal incentive contracts in teams which consist of two groups of agents di¤ering in their productivity, and in situations where team members feel a social pressure to exert similar e¤ort levels. We show that it is \u85rst-best optimal to induce the more productive agents to exert higher e¤ort. We then characterize the equilibrium under agency. The general conclusion we obtain regarding economic incentives is that the principal always chooses to give the less produc-tive agents the strongest incentives. That is, less productive agents are o¤ered a salary scheme that is more responsive to the team out-put than it is the case for the more productive agents. Furthermore, we show that the principal is able to implement the unique \u85rst-best solution. In this solution less productive agents exert less e¤ort, and all agents experience peer pressure