Endogenous leadership in incentive contracts

We study the effect of leadership on incentive contracts in a moral-hazard framework. In our model, agents are allowed to choose the timing of their actions. The agents may choose their effort levels simultaneously or sequentially. We show that relative performance evaluation leads to a subgame in which agents make simultaneous effort choices, whereas joint performance evaluation yields a subgame in which agents make sequential effort choices. Since agents exert more effort in the sequential game, the principal uses joint performance evaluation to induce the leader–follower relationship among agents.

► This paper studies a principal-two agent problem where the timing of the effort choices by agents is determined endogenously.
► The agents’ decisions are determined by the way they are compensated. Thus, the incentive compatibility constraints are endogenous to the principal's wage scheme.
► The agents increase their supply of effort by playing sequentially and the principal benefits from their leader–follower behavior.
► The principal's optimal scheme is to compensate the agent based on joint performance to create leadership among the agents.