Optimal contract design and agency cost analysis under inequity aversion

A series of economic game experiments have been proving that most people are not only self-interest but also inequity averse, and hereby will suffer disutility in the face of any unfair allocation. However, the standard contract theory, which accepts the traditional economic assumption of self-interest, has ignored inequity aversion. In this paper, by incorporating the inequity aversion into the standard frame of optimal contract design, we designs the optimal contract for multiple agents with the assumption of risk neutrality and the constraint of limited liability, and further analyzes the influence of the inequity aversion on agency cost. It is found that the optimal contract for multiple inequity averse agents is the joint contract by which the payment to each agent is determined by his own output and otherspsila even when they are independent totally, while that for self-interest independent agents is be the independent contract by which the payment to each agent only lies on his own output as revealed in the standard contract theory. Therefore, the sufficient statistics principle of standard contract theory does not work for inequity-averse agents any more. Furthermore, we also shows that the inequity aversion will not only definitely change the structure of optimal contract, but also decrease the agency cost and hereby promote the incentive efficiency. Therefore, it is very important for employers to screen and evaluate the inequity aversion of employees in order to design suitable incentive systems.