Incentive design for reference-dependent preferences

Víctor González-Jiménez*

*Corresponding author for this work

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We investigate the optimal design of incentives when agents exhibit reference dependence. The theoretical framework of this paper incorporates the most prominent accounts of reference-dependent preferences and the most frequently used reference point rules. Such a general treatment of preferences allows us to characterize sufficient conditions on preference for the optimality of bonuses. We find that the optimal contract must include a bonus when agents suffer from loss aversion or exhibit sufficiently strong diminishing sensitivity. Moreover, we show that such a result holds when the reference point is either exogenous or deterministic. This paper provides a rationale for incentive schemes including bonuses grounded in preference.

Original languageEnglish
Pages (from-to)493-518
Number of pages26
JournalJournal of Economic Behavior and Organization
Publication statusPublished - May 2024

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