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The principal's dilemma

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Working paper
Dunia Lopez-Pintado and Juan D. Moreno-Ternero
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A recurrent dilemma in team management is to select between a team-based and an individual-based wage scheme. We explore such a dilemma in a simple model of production in teams, in which the team members may differ in their effort choices and qualification. We show that, in spite of enhancing output as the basis for payment, a team-based wage scheme might be less profitable for the principal than an individual-based wage scheme. We also highlight a deep misalignment between designing optimal (output-based) incentives for a team and treating its members impartially. Finally, upon introducing the possibility of liquidity constraints in our model, we provide rationale for the so-called “rich get richer” hypothesis.
Developed by Paolo Gittoi