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Journal of Law, Economics, and Organization Advance Access originally published online on September 3, 2007
Journal of Law, Economics, and Organization 2008 24(1):120-137; doi:10.1093/jleo/ewm037
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© The Author 2007. Published by Oxford University Press on behalf of Yale University. All rights reserved. For permissions, please email: journals.permissions@oxfordjournals.org

Optimal Contracts When a Worker Envies His Boss

Robert Dur*

Erasmus University Rotterdam, and CESifo

Amihai Glazer**

University of California, Irvine

* Department of Economics, Erasmus University, Rotterdam, The Netherlands. Email: dur{at}few.eur.nl.

** Department of Economics, University of California, Irvine. Email: aglazer{at}uci.edu.

A worker's utility may increase with his income, but envy can make his utility decline with his employer's income. This article uses a principal-agent model to study profit-maximizing contracts when a worker envies his employer. Envy tightens the worker's participation constraint and so calls for higher pay and/or a softer effort requirement. Moreover, a firm with an envious worker can benefit from profit sharing, even when the worker's effort is fully contractible. We discuss several applications of our theoretical work: envy can explain why a lower-level worker is awarded stock options, why incentive pay is lower in nonprofit organizations, and how governmental production of a good can be cheaper than private production.


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