PEER PRESSURE IN AN AGENCY RELATIONSHIP

We investigate the role of peer pressure in influencing the optimal in centive scheme offered to workers engaged in team production. We devel op an agency model of peer policing to identify factors that affect th e extent of mutual monitoring. As the principal must compensate worker s for their monitoring efforts and the costs that peer pressure impose s on workers, introducing peer pressure alters the optimal compensatio n package. We establish conditions under which the principal reduces t he marginal compensation rule to reduce monitoring efforts. As such, p eer pressure provides a rationale for a reduced link between compensat ion and output in a team setting.