Status, Incentives and Random Favouritism

The paper identifies a condition under which favouritism is beneficial to the principal even when the favoured agent is selected randomly. This paper also characterizes how the optimal incentive scheme changes in presence of random favouritism. Using a moral hazard framework with limited liability it is shown that in presence of favouritism principal can optimally decrease monetary incentive when the potentially favoured group size is small. In spite of a fall in optimal effort the paper predicts that favouritism can emerge as an optimal outcome when return of the firm is low