Gift-exchange, incentives, and heterogeneous workers

By incorporating reciprocity in an otherwise standard principalagent model, I investigate the relation between monetary gift-exchange and incentive pay, while allowing for worker heterogeneity. I assume that some, but not all, workers care more for their principal when they are convinced that the principal cares for them. The principal can be egoistic or altruistic. Absent worker heterogeneity, an altruistic principal signals his altruism by o¤ering relatively weak incentives and a relatively high expected total compensation. However, the latter is not always required to credibly signal altruism. Furthermore, since some workers do not reciprocate the principal’s altruism, the principal may …nd it optimal to write a contract that simultaneously signals his altruism and screens reciprocal worker types. Such a contract is characterised by excessively strong incentives and a relatively high expected total compensation.