Ron KANIEL, University of Rochester, Simon School of Business
“Relative Pay for Non-Relative Performance: Keeping up with the Joneses with Optimal Contracts”
We consider multi-agent contracting when agents have “keeping up with the Joneses” (KUJ) preferences. Although contracts appear inefficient, as performance seems inadequately benchmarked, when a single principal can commit to a public contract, the optimal contract hedges agents’ relative wage risk without sacrificing efficiency. With multiple principals, or a principal that is unable to commit, a “rat race” emerges in which agents are more productive, but wages increase even more, reducing profits and undermining efficiency. Renegotiation reduces or enhances efficiency depending on whether KUJ effects are weak or strong. Public disclosure of contracts across firms can cause output to collapse.