Incentives and Relative Wealth Concerns

If risk-averse agents prefer to be wealthier both in absolute terms and relative to their peers (relative wealth concerns), then (1) they prefer positive correlation, and (2) they are averse to negative correlation between their payoffs. A laboratory experiment shows that subjects prefer positively correlated payoffs. Subjects interested in relative payoffs display stronger aversion to negatively correlated payoffs. This novel evidence has implications that motivate firms' extensive use of broad-based incentive plans and firms' scarce use of Relative Performance Evaluation (RPE) contracts.