Economic Analysis of Decision Making and Organization Based on Other-Regarding Preferences

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In this research I attempt to obtain new theoretical insights by combining the standard moral hazard models of principal-agent relationships with theories of other-regarding (inequity averse or status-seeking) preferences, that are consistent with many experimental results. In the benchmark principal-agent model, the principal and the agent are both risk neutral, while the agent is wealth constrained, and hence the basic tradeoff between incentives and rent extraction arises. I show that other-regarding preferences interact with incentives in nontrivial ways. In particular, the principal is in general worse off as the agent cares more about the well-being of the principal. I then extend the analysis to a multi-agent setting. When each agent cares about the well-being of the other agent, either a team contract or a relative performance contract is optimal even though there is no technological externality nor correlation. The extreme team contract is "fair" and more likely to be optimal as actions become mutually observable. However, team contracts are never optimal when the agents are competitive or status-seeking. I also show that the information structure also affects the optimal contract. Another important result I obtain is that the optimal contract for self-interest agents changes drastically when a small degree of other-regarding preferences is introduced. Under the technological assumption of the model, if the agents are self-interested, there is an optimal independent contract in which the payment scheme for each agent depends only on the outcome of his project. However, when the agents become other-regarding, however small the changes are, no independent contract is optimal any longer and the optimal contract is generically unique.