Inequity Aversion and Team Incentives

Abstract We study optimal contracts in a simple model where employees are averse to inequity, as modeled by Fehr and Schmidt (1999) . A “selfish” employer can profitably exploitenvyorguiltby offering contracts which create inequity off‐equilibrium, i.e., when employees do not meet his demands. Such contracts resembleteamandrelative performancecontracts. We derive conditions for inequity aversion to be in itself a reason to form work teams of distributionally concerned employees, even in situations in which effort is contractible.