Optimal Contracting with Aspirational Utility
Feb 17, 2026
Working Paper No. 00201-00
This paper characterizes the optimal contract when the agent is endowed with aspirational utility. Our analysis reveals that effort and aspirations act as complements: the principal utilizes aspirational ``boosters'' to induce local risk-loving behavior, reducing the welfare costs of incentives and leading to higher effort levels. We find that the optimal compensation contract features a discontinuous jump to reach the aspiration point after good performance, followed by a region of ``sticky wages'' where compensation remains constant despite sustained high effort. Importantly, aspirations not only serve to incentivize effort by making the agent ``aspire'' to reach a high compensation level, but also by the fear of losing it. Finally, we explore cross-sectional implications, showing that more productive firms reach aspiration thresholds sooner, while high volatility firms optimally delay these rewards due to increased agency costs.