Inequity aversion in a model with moral hazard

In this paper we solve a parametric moral hazard model that incorporates risk and inequity aversion. In the model, the worker's effort is not contractible but the employer can link the worker's compensation to the revenue, a measure probabilistically related to the effort. The model can account for some regularities observed in the experimental data such as loss avoidance. It also suggests that inequity aversion may amplify variability of the worker's compensation. Data from a within-subject experiment is used to estimate the unobservable parameter of inequity aversion. Experimental results generally support the model's predictions. In the setting considered, the estimate of the inequity aversion parameter implies that about 30 percent of the change in the revenue range is passed into the worker's incentive payment.