When Should the Talented Receive Weaker Incentives? Peer Pressure in Teams

We study optimal incentive contracts offered to teams where team members feel a social pressure to exert similar effort levels. The team consists of two groups of agents differing in their productivity. We characterize first best and the equilibrium under agency. Regarding economic incentives, the principal has to adjust the incentives away from the first-best incentives that would arise in the absence of peer pressure. In equilibrium less productive agents exert less effort and all agents experience peer pressure.