On the optimality of competition within a team

This paper studies the optimal team contract when the principal observes a noisy ranking of the efforts of the two team members. The objective of this paper is to understand whether it is optimal to use this competition‐promoting noisy ranking in a team setting. It is shown that noisy ranking is always part of the optimal contract both in static and repeated settings. Even though noisy ranking promotes competition between team members, it does not have a negative effect on peer monitoring incentives in a repeated setting. In summary, competition does not need to be damaging in a team setting.