Incentives and group identity

This paper investigates in a principal–agent environment whether and how group membership influences the effectiveness of incentives and when incentives can have “hidden costs”, i.e., a detrimental effect. We show experimentally that in all interactions control mechanisms can have hidden costs for reasons specific to group membership. In within-group interactions control has detrimental effects because the agent does not expect to be controlled and reacts negatively when being controlled. In between-group interactions, agents perceive control more hostile once we condition on their beliefs about principals' behavior. Our finding contributes to the micro-foundation of psychological effects of incentives. •We investigate the effect of group membership on the effectiveness of incentives.•Does group membership affect whether incentives have “hidden costs”, i.e., are detrimental?•Evidence comes from a principal–agent experiment.•In both, in-group and between-group interactions, control mechanisms have hidden costs.•The reasons for the hidden costs are group specific.