INCENTIVES ‘AND’ STATUS
Motivation and Focus :
 Role
of Monetary incentives in Moral Hazard:
studied widely in Organization Theory.
 Status ‘as’ a non- monetary
incentive and its
implication in economic theory has gained
importance in recent studies.
 But how the optimal incentive scheme changes for
agents with different status has not been studied
much.
 This paper has explored how the optimal monetary
incentive scheme varies with persons holding
different status.
 Observe:
When a flat monetary incentive is offered to agents
across all status levels an agent of higher status
might not value the incentive as highly as an agent
holding low status. Because comparison matters to
human beings.
 Given the hierarchical structure (positions or status)
of a firm , interplay between monetary incentive
‘and’ status of status-conscious and intrinsically
motivated agents is studied.
Status-conscious: if agents value the same
monetary incentive differently.
Motivated: if agents get intrinsic benefit through
her participation in the job.
Review of literature:
On Social Comparision:
 Status consciousness arises from the fact that human
beings make social comparison. This fact has been
empirically validated by the works of Duesenberry
(1949), Festinger (1954), Easterlin(1974), Clark
and Oswald (1996),McBride (2001), Luttmer
(2005), Hopkins and Kornienko(2004), Brown et
al(2007), Clark et al(2008).
 K.Fleissbach et al(2007) has also asserted through
neurophysiological evidence that human beings
make social comparison.
Review of literature
On Status as an incentive:

Frank (1985), Fehr and Schmidt (1999), Dubey and
Geanakoplos (June, 2004), Huberman, Loch and
Önçüler (2004), Moldovanu et al (2007), Brown et
al (2007) Besley and Ghatak (2008), Auriol and
Renault (2008), Dhillon and Herzog-Stein (2009)
contributes to the growing and influential literature
exploring the importance of status as a nonpecuniary incentive to elicit the desired outcome.
Framework of the Model:
 A risk – neutral principal.
A risk-neutral “incentive conscious” and status
conscious agent.
 The principal hires the agent to carry out a project.
 The project can either succeed or fail.
 If the project succeeds the outcome is qH=1,if the
project fails the outcome is qL = o.
 If the project succeeds principal gets a fixed payoff
of π and 0 if the project fails.
 The agent puts effort denoted by e; which is taken
as the probability of success.[FOSD]

Framework of the Model:
The cost of effort is assumed to be
 The variables of contract, signed between the
principal and the agent, are fixed wage ‘F’ and
bonus ‘b’.
 A limited liability constraint operates, i.e., the agent
must be given the minimum payoff level
 The agent has an outside option (reservation utility),
u0
 The agent derives a non-pecuniary benefit (or
pleasure) ‘M’ from carrying out the project.

How status has been modeled ?
The agent is status conscious in the following way:
 Agents of higher status value the same bonus b less
than the agents of lower status (due to the presence
of social comparison)
 Status of the agent is denoted by α, where αϵ(0,1]
 An agent of status level indexed by α values the
monetary incentive by αb.
 Lower α means higher status and thus an agent with
higher status values the same monetary incentive
lesser.
 α is assumed to be common knowledge.
Optimal contract:
 Two technical assumptions:


Assumption 1 : π + M < 1
Assumption 2:
 Modified version of the moral hazard structure with
limited liability a la Innes (1990), Besley and
Ghatak (2005), Banerjee (2011)is used.
Effort observable:
 Under the first-best the optimization problem
becomes
 The optimal first best effort is

The maximum expected joint surplus is
SFB =
Effort unobservable:
The optimization problem becomes:
subject to the following constraints:
 Limited liability constraint: F > , F + αb>
 Individual Rationality constraint:
 Incentive compatibility constraint:
e = arg
=> e = M+αb
Lemmas:
 LEMMA 1: Under the optimal incentive contract at
least one of the participation constraint and limited
liability constraint will bind.
 LEMMA
2:When status is incorporated in the
system in such a way that the worth of the bonus is
not valued to its full extent by the agents (i.e. when
α <1) then e is always less than the first best.
 LEMMA 3:
The limited liability constraint will
bind if the agent’s status in the firm is sufficiently
low (i.e., α is high).
Proposition 1:
 The status of the agent is sufficient low such that
the limited liability binds.
 If assumption (1), (2) hold ,and reservation payoff
of the agent
then an optimal contract
{b*, F*}can be characterized as follows:
I. The fixed wage is set at the subsistence level, i.e.,
F=
II. The bonus payment is characterized as follows
A)When outside option is low i.e.,
 If
then
 If
then
Proposition 1:
Note that for
increased status leads to a
decrease in the optimal monetary incentive.
B) When outside option of the agent is sufficiently
high i.e.,
>0.
Interestingly increased status (lower α) leads to an
increased optimal monetary incentive.
III. The optimal effort is given by
e* = M + αb*
Explanation and Intuition:
F = as increasing F won’t affect effort and risk
neutral agent cares only about minimum fixed
wage and not about the distribution of payoffs
across states.
II. b is the only as well as a costly instrument to
elicit effort.
◦ When motivation is high no need to provide any
bonus
◦ When motivation is low,
,b=
and
I.
Explanation and Intuition:
 Direct relation between α and b for low outside
option agents:
For a given b lower α leads to lower e, reducing
expected payoff of the principal. Therefore,
principal reduces b and this is possible since the
outside option of the agent is sufficiently low and
the participation constraint is non-binding.
 Inverse relation between α and b for high outside
option agents:
Principal needs to compensate the agent for the
forgone outside option and this is irrespective of the
status of the agent and the degree of motivation.
Proposition 1I:
 Agents of very high status such that limited
liability doesn’t bind.
 Given the assumptions 1 and 2 and higher the
status of the agents an optimal contract {F**, b**}
can be characterized as follows:
(i). If M>
π then b**=0
(ii). If M<
π, then b**=
(iii) The optimal fixed wage is given by
(iv)The optimal effort is given by
Explanation and Intuition:
 When intrinsic motivation is sufficiently high then
no explicit incentives are required to elicit costly
effort.
 When agents are not sufficiently motivated then
explicit incentives are needed irrespective of the
range of the reservation utility of the agent.
 Direct Relation between α and optimal b:
For a given b lower α leads to lower e, reducing
expected payoff of the principal. The principal can
optimally reduce b and increase F optimally (since
limited liability does not bind) such that the
participation constraint binds.
Extension:
 Assume correlation between Status and
Motivation:
I) Positive:
II) Negative:
 For both the cases the all result of the baseline
model goes through unambiguously.
Future Works:
 Intend to analyze the structure when the incentive is
not reached to the deserving agent due to favoritism
of the principal or assessment problem of the
performance of the agent.
 Factors like social norms, dimension of relationship
with the principal, etc. can effect the motivation of
the agent. It is intended to incorporate this feature in
this framework and determine the optimal incentive
scheme.
Thank You