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Incentive design for reference-dependent preferences

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  • González-Jiménez, Víctor

Abstract

We investigate the optimal design of incentives when agents exhibit reference dependence. The theoretical framework of this paper incorporates the most prominent accounts of reference-dependent preferences and the most frequently used reference point rules. Such a general treatment of preferences allows us to characterize sufficient conditions on preference for the optimality of bonuses. We find that the optimal contract must include a bonus when agents suffer from loss aversion or exhibit sufficiently strong diminishing sensitivity. Moreover, we show that such a result holds when the reference point is either exogenous or deterministic. This paper provides a rationale for incentive schemes including bonuses grounded in preference.

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  • González-Jiménez, Víctor, 2024. "Incentive design for reference-dependent preferences," Journal of Economic Behavior & Organization, Elsevier, vol. 221(C), pages 493-518.
    • Handle: RePEc:eee:jeborg:v:221:y:2024:i:c:p:493-518
    DOI: 10.1016/j.jebo.2024.03.005
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    More about this item

    Keywords

    Contract theory; Reference dependence; Principal-agent models; Loss aversion; Bonuses;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • J41 - Labor and Demographic Economics - - Particular Labor Markets - - - Labor Contracts
    • M52 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics - - - Compensation and Compensation Methods and Their Effects
    • M12 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Administration - - - Personnel Management; Executives; Executive Compensation

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