# 12-054/1 (2012-05-16)

Author(s)
Robert Dur, Erasmus University Rotterdam, CESifo, and IZA; Jan Tichem, Erasmus University Rotterdam
Keywords:
Altruism, spite, social relations, incentives, relational contracts, efficiency wages, subjective performance evaluation, Nash bargaining
JEL codes:
D23, J33, M52, M55

This paper studies how social relationships between managers and employees affect relational incentive contracts. To this end we develop a simple dynamic principal-agent model where both players may have feelings of altruism or spite toward each other. The contract may contain two types of incentives for the agent to work hard: a bonus and a threat of dismissal. We find that good social relationships undermine the credibility of a threat of dismissal but strengthen the credibility of a bonus. Among others, these two mechanisms imply that better social relationships sometimes lead to higher bonuses, while worse social relationships may increase productivity and players' utility in equilibrium.