Endogenous formation of optimal teams

We study the role of incentives in determining how individuals with high and low ability endogenously form teams with homogeneous or heterogeneous abilities. Standard incentives that reward the best-performing team (team incentives) or the best member of each team (individual incentives) consistently lead to the formation of homogeneous teams, even when socially inefficient. Conversely, equal sharing rules, which offer all members an identical share of total production, elicit optimal matching but are vulnerable to moral hazard. We show that hybrid incentives, which combine team and individual incentives, elicit optimal matching and are robust to moral hazard. We conduct two experimental studies showing that hybrid incentives produce significantly more optimal teams than standard incentives, though fewer than under equal sharing.