Endogenous favouritism with status incentives: A model of optimum inefficiency

The paper identifies conditions under which ‘inefficient’ favouritism emerges as an optimal outcome even when the principal do not exhibit ex-ante preferential bias for any particular agent. We characterize how the optimal incentive scheme is influenced in the presence of status incentives. Using a moral hazard framework with limited liability in a multi-agent framework, it is shown that in presence of higher valuation for status incentive inefficient favouritism is more likely to dominate over fairness. Moreover, inefficient favouritism emerges as the optimal outcome when revenue of the firm is sufficient low.