Altruism and Relational Incentives in the Workplace

• DOI: http://doi.org/10.1111/jems.12099
• Author: Robert Dur,Jan Tichem
• Date: 01 September 2015
• Published date: 01 September 2015

Altruism and Relational Incentives in the Workplace

ROBERT DUR

Erasmus University Rotterdam, Department of Economics,

and Tinbergen Institute, Rotterdam, The Netherlands

dur@ese.eur.nl

JAN TICHEM

Erasmus University Rotterdam, Department of Economics,

and Tinbergen Institute, Rotterdam, The Netherlands

jan.tichem@acm.nl

This paper studies how altruism between managers and employees affects 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 altruism

undermines the credibility of a threat of dismissal but strengthens the credibility of a bonus.

Among others, these two mechanisms imply that higher altruism sometimes leads to higher

bonuses, whereas lower altruism may increase productivity and players’ utility in equilibrium.

1. Introduction

Incentive contracts for workers often do not rely on objective performance measuresonly.

Indeed, “thinking of any job in which subjective evaluation or supervisor discretion does

not play some role in incentives is difficult” (Gibbs, 2013, p. 411). Subjective performance

evaluation sometimes affects pay. For example, 34% of employees in the industrial sector

in the United Kingdom received some form of merit pay “which depended on a subjec-

tive judgement by a supervisor or manager of the individual’s performance” (quoted

by MacLeod and Malcomson, 1998, from Millward et al., 1992, p. 388).1However, the

use of subjective performance evaluation is not restricted to bonus pay only. Managers

and employees regularly have an understanding that the employment relationship is

only continued if performance is satisfactory, which is often a subjective matter. If the

job is valuable to a worker, such a threat of dismissal also works as an incentive de-

vice (Shapiro and Stiglitz, 1984). A prominent example is Henry Ford’s five-dollar-day

program, which almost doubled wages (Raff and Summers, 1987). Indirect evidence

that many firms use efficiency wages as an incentive device is that bonuses are more

common when the unemployment rate is low, that is, when keeping a job is less valu-

able to a worker (MacLeod and Parent, 2000).

Subjective performance evaluation can overcome some well-known problems re-

lated to the use of objective performance measures, such as multitasking concerns,

Wegratefully acknowledge comments and suggestions by two referees and a co-editor of this journal, Hannes

Mueller, Arjan Non, Canice Prendergast,Anja Sch ¨

ottner, Robin Zoutenbier,Floris Zoutman, and participants

to the 2011 CESifo Area Conference on Behavioural Economics in Munich, the 2011 ZEW/TinbergenInstitute

Workshopon Behavioural Personnel Economics in Mannheim, the 2012 Workshop on the Social Dimension of

Organizations in Budapest, and the 2012 Annual Congress of the European Economic Association in M´

alaga.

1. See MacLeod and Parent (2000) and Gibbs et al. (2004) for similar evidence concerning subjectively

determined bonuses in other sectors.

C2015 Wiley Periodicals, Inc.

Journal of Economics & Management Strategy, Volume24, Number 3, Fall 2015, 485–500

486 Journal of Economics & Management Strategy

measurement costs, and lack of flexibility. When such problems are severe, managers

may revert to “relational contracts” in which employee performance is evaluated sub-

jectively in a holistic way (Gibbons, 1998; Prendergast, 1999). However,a difficulty with

relational contracts is that they cannot be enforced in court, but instead must be self-

enforcing. Promises and threats contained in a relational contract may thereforebe weak

as they are constrained by their credibility. In recent decades, a rich theoretical literature

has developed studying the optimal design and use of relational contracts (see, among

others, Bull, 1987; MacLeod and Malcomson, 1989, 1998; Baker et al., 1994; Levin, 2003).

The present paper contributes to this literature by studying how altruism between

managers and employees affects the optimal design of relational contracts. To this end,

we develop a simple dynamic principal–agent model where both players have some

bargaining power. A moral hazard problem exists because both the agent’s effort and

performance are nonverifiable. For this reason, contracts that condition on effort or

performance are not enforceable in court, and must therefore be self-enforcing. The

contract may contain two types of incentives for the agent to work hard: a promise to

pay a bonus for good performance as in, for example, Baker et al. (1994), and a high

wage combined with a threat of dismissal following bad performance (efficiency wages)

as in Shapiro and Stiglitz (1984). Our key innovation is that we allow both players

to have feelings of altruism and/or spite toward each other. These feelings need not

be symmetric. Our analysis yields several potentially testable hypotheses as well as a

number of management implications.

So far, most studies on relational contracts have abstracted from altruism or spite

between the contracting parties. This is somewhat surprising given the prevalence of re-

lational contracts in the workplace, as described, and the abundance of evidence for the

existence of altruism and spite between managers and employees. Surveys among man-

agers reveal that friendships between managers and employees occur frequently (see

for instance, Berman et al., 2002). Furthermore, Campbell and Kamlani (1997) find that a

large majority of US compensation managers deem good-quality manager–employee re-

lations more important in determining effort than good working conditions, high wages,

and monitoring.2There is also evidence for the occurrence of bad manager–employee

relationships. Moerbeek and Need (2003) report Dutch data showing that in 8% of the

jobs respondents had in their lives, they got along with their manager badly or very

badly. More tentatively, Kahneman et al. (2004) reportdiary evidence from a US sample

of employed women showing that of all regular daily activities, respondents dislike

most to interact with their boss.3

Some of the results from the present analysis can best be compared against the

benchmark of the traditional relational contracts literature, which commonly assumes

selfish preferences. In this respect, our first key result is that higher altruism (meaning

that either the principal, the agent, or both are more altruistic) improves the credibility

of a promise to pay a bonus, ceteris paribus. The reason is twofold. First, higher altruism

makes the relational contract more valuable, which gives the principal stronger incen-

tives to adhere to it. Second, an altruistic principal partly internalizes the benefits of

the bonus to the agent, which reduces the principal’s costs of honoring the contract.

2. In line with this, an extensive literature in organizational psychology has established a strong positive

correlation between the quality of the manager–employee relationship and employee performance (see, e.g.,

Wayne et al., 1997, and Rhoades and Eisenberger, 2002).

3. There is also substantive laboratory evidence indicating that a majority of people are altruistic, even to

strangers, see the review by Andreoni et al. (2008). However, other people areactually spiteful. For instance,

Andreoni and Miller (2002) find that 55% of their sample is altruistic whereas 23% is spiteful.