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Relational Incentive Contracts and Performance Measurement

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  • Chi, Chang Koo

    (Dept. of Economics, Norwegian School of Economics and Business Administration)

  • Olsen, Trond E.

    (Department of Business and Management Science)

Abstract

This paper analyzes relational contracts under moral hazard. We first show that if the available information (signal) about effort satisfies a generalized monotone likelihood ratio property, then irrespective of whether the first-order approach (FOA) is valid or not, the optimal bonus scheme takes a simple form. The scheme rewards the agent a fixed bonus if his performance index exceeds a threshold, like the FOA contract of Levin (2003), but the threshold can be set differently. We next derive a sufficient and necessary condition for non-verifiable information to improve a relational contract. Our new informativeness criterion sheds light on the nature of an ideal performance measure in relational contracting.

Suggested Citation

  • Chi, Chang Koo & Olsen, Trond E., 2018. "Relational Incentive Contracts and Performance Measurement," Discussion Paper Series in Economics 7/2018, Norwegian School of Economics, Department of Economics.
  • Handle: RePEc:hhs:nhheco:2018_007
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    Cited by:

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    2. Ola Kvaløy & Trond E. Olsen, 2019. "Relational Contracts, Multiple Agents, and Correlated Outputs," Management Science, INFORMS, vol. 65(11), pages 5360-5370, November.

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    More about this item

    Keywords

    Relational contracts; non-verifiable performance measures; first-order approach; bonus scheme; informativeness criterions;
    All these keywords.

    JEL classification:

    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation

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