This paper studies how social relationships between managers and employees affect relational incentive contracts. To this end we develop a simple dynamic principal-agent model where both players may have feelings of altruism or spite toward each other. The contract may contain two types of incentives for the agent to work hard: a bonus and a threat of dismissal. We find that good social relationships undermine the credibility of a threat of dismissal but strengthen the credibility of a bonus. Among others, these two mechanisms imply that better social relationships sometimes lead to higher bonuses, while worse social relationships may increase productivity and players' utility in equilibrium.

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Tinbergen Institute
Tinbergen Institute Discussion Paper Series
Discussion paper / Tinbergen Institute
Tinbergen Institute

Dur, R., & Tichem, J. (2012). Social Relations and Relational Incentives (No. TI 2012-054/1). Discussion paper / Tinbergen Institute (pp. 1–33). Retrieved from