Scandinavian Working Papers in Economics

Discussion Papers,
Norwegian School of Economics, Department of Business and Management Science

No 2005/7: Team Incentives in Relational Employment Contracts

Ola Kvaløy () and Trond E. Olsen ()
Additional contact information
Ola Kvaløy: Norsk hotellhøgskole, Institutt for økonomi og ledelse, University of Stavanger, Postal: University of Stavanger, 4036 Stavanger, Norway
Trond E. Olsen: Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration, Postal: NHH , Department of Finance and Management Science, Helleveien 30, N-5045 Bergen, Norway

Abstract: The paper analyzes conditions for implementing incentive schemes based on, respectively joint, relative and independent performance, in a relational contract between a principal and a team of two agents. A main result is that the optimal incentive regime depends on the productivity of the agents, or more precisely on the returns from high effort. This occurs because agents’ productivities affect the principal’s temptation to renege on the relational contract. The analysis suggests that we will see a higher frequency of relative performance evaluation (RPE) - and schemes that lie close to independent performance evaluation - as we move from low-productive to high-productive environments. In particular, it is shown that if effort-productivity is sufficiently high, the optimal scheme for the principal is (for a range of discount factors) a collusion-proof RPE scheme, even if there is no common shock that affects the agents’ output.

Keywords: Incentive schemes; joint performance; relative and independent performance; relational contracts

JEL-codes: J41

33 pages, October 12, 2005

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