Optimal contracting with altruism and reciprocity

•We study a principal–agent model where players have altruistic and reciprocal motives.•We show that, relative to the selfish benchmark, efficiency improves when players are altruistic.•But, an increase of the agent's altruism and reciprocal attitude by both players has ambiguous effects on efficiency.

Motivated by the recent experimental evidence on altruistic behavior, we study a simple principal–agent model where each player cares about other players' utility, and may reciprocate their attitude towards him. We show that, relative to the selfish benchmark, efficiency improves when players are altruistic. Nevertheless, in contrast to what may be expected, an increase in the degree of the agent's altruism as well as a more reciprocal behavior by players has ambiguous effects on efficiency. We also consider the effects of the presence of spiteful players and discuss how monetary transfers between players depend on their degrees of altruism and spitefulness.