A worker's utility may increase in his own income, but envy can make his utility decline with his employer's income. Such behavior may call for high-powered incentives, so that increased effort by the worker little increases the income of his employer. This paper employs a principal-agent model to study optimal incentive contracts for envious workers under various assumptions about the object and generality of envy. Envy amplifies the effect of incentives on effort and, therefore, increases optimal incentive pay. Moreover, envy can make profit-sharing optimal, even when the worker's effort is fully contractible. We discuss several applications of our theoretical work. For example, envy can explain why lower-level workers are awarded stock options, why incentive pay is usually lower in non-profit organizations, and higher in larger firms. Envy may also make governmental production of a good more efficient than private production.

compensation, contracts, envy, incentives, moral hazard, principal-agent, profit-sharing, public vs. private production, stock options
Wage Level and Structure; Wage Differentials by Skill, Training, Occupation, etc. (jel J31), Compensation Packages; Payment Methods (jel J33), Compensation and Compensation Methods and Their Effects (stock options, fringe benefits, incentives, family support programs, seniority issues) (jel M52)
hdl.handle.net/1765/6649
Tinbergen Institute Discussion Paper Series
Tinbergen Institute

Dur, A.J, & Glazer, A. (2004). Optimal Incentive Contracts when Workers envy their Boss (No. TI 04-046/1). Tinbergen Institute Discussion Paper Series. Retrieved from http://hdl.handle.net/1765/6649