Incentive design for reference-dependent preferences

Víctor González-Jiménez

Journal of Economic Behavior & Organization, 2024, vol. 221, issue C, 493-518

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.

Keywords: Contract theory; Reference dependence; Principal-agent models; Loss aversion; Bonuses (search for similar items in EconPapers)
JEL-codes: D82 D86 J41 M12 M52 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jeborg:v:221:y:2024:i:c:p:493-518

DOI: 10.1016/j.jebo.2024.03.005

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