Abstract
An emerging body of research on teams highlights the importance of implicit incentives that rely on mutual monitoring among team members. While prior research on mutual monitoring in team production settings assumes agents have identical abilities, this paper considers teams with productively heterogeneous agents. In cross-functional teams, productive heterogeneity does not alter the qualitative nature of incentives. In functional teams, heterogeneity introduces the need for additional constraints to ensure that both more and less productive agents are motivated to cooperate, which increases the cost of providing cooperative incentives. The optimal means of preventing collusion in functional teams is to employ asymmetric contracts, where the more productive agent receives higher-powered collusion-proof incentives. Productive heterogeneity is advantageous in functional teams when there is a high degree of productive substitutability and/or a high discount factor. This is because these conditions lead to a severe collusion problem, which is mitigated by productive heterogeneity. When the productive substitutability and/or the discount factor are low, the optimal productive heterogeneity is either small or none. We also study optimal team design, allowing the principal to choose between a functional team and a cross-functional team and the optimal level of productive heterogeneity.