Contracting With Self-Esteem Concerns

TL;DR: In this paper, self-esteem concerns are incorporated into an otherwise ordinary principal-agent framework and examined its impact on the optimal incentive scheme and the agent's behavior, especially focusing on a form of intrapersonal strategy known as self-handicapping.

Abstract: It is widely accepted in social psychology that the need to maintain and enhance self-esteem is a fundamental human motive We incorporate this factor into an otherwise ordinary principal-agent framework and examine its impact on the optimal incentive scheme and the agent's behavior, especially focusing on a form of intrapersonal strategy known as self-handicapping Incorporating self-esteem concerns into a contracting situation yields an implication that goes against the conventional wisdom: the standard tradeoff between risk and incentives may break down (ie, more uncertainty reduces the agency cost) in the presence of self-esteem concerns because uncertainty mitigates the need for self-handicapping This result provides a potential reason for why we do not empirically observe this tradeoff in a robust manner We characterize an intuitive condition for this anomaly to arise and present a set of testable implications The present framework also reveals why and how team production can be more profitable, providing an explanation for the increasing popularity of team production Finally, this simple logic is applied to draw additional implications for hidden costs of external enforcers such as evaluation, monitoring and direct control over workers, which are discussed extensively in social psychology