Team-Based Incentives in Problem-Solving Organizations

This paper investigates a repeated employment relationship between a principal and a team of agents hired to solve a series of problems. With non-verifiable output, team-based incentives can relax the principal’s credibility constraint by smoothing bonus payments over time. Team incentives also induce free-riding, but the principal prefers them to individual incentives if effort costs are moderate and problems difficult to solve. We show that a simple mixture of an individual and team bonus constitutes the optimal relational contract under joint performance evaluation. If team size is endogenous, team incentives can allow the principal to motivate more agents, yet he may still prefer individual incentives that are less efficient