Behavioral Economic Theory on Wage Schemes

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We study compensation schemes as focusing on a prominent behavioral element, loss aversion. We mainly conduct two research. (1) We investigate a multi-agent moral-hazard model where agents have expectation-based reference dependent-preferences. We show the optimality of team incentives. Because the agents are loss averse, they have first-order risk aversion to wage uncertainty. This causes the agents to work harder when their own failure is stochastically compensated through other agents’ performance. In the optimal contract, both high- and low-performance agents are equally rewarded if most agents accomplish their projects; otherwise only high-performance agents are rewarded. (2) We analyze a task-assignment model in which a principal assigns a task to one of two agents depending on future states. If the agents have concave utility, the principal assigns the task to each of them contingent on the state. In contrast, if the agents are loss averse, we show that a state-independent assignment-assigning the task to a single agent in all states-can be optimal even when the principal can write a contingent contract at no cost.