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Abstract

Consider a principal-agent relationship in which more effort by the agent raises the likelihood of success. This paper provides conditions such that no success bonus induces the agent to exert more effort and the optimal contract is independent of success. Moreover, success bonuses may even reduce effort and thus the probability of success. The reason is that bonuses increase the perceived income of the agent and can hence reduce his willingness to exert effort. This perceived income effect has to be weighed against the incentive effect of the bonus. The trade-off is determined by the marginal effect of effort on the success probability in relation to this probability itself (success hazard-rate of effort). The paper also discusses practical implications of the finding.

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File URL: http://hdl.handle.net/10.1111/j.1468-0475.2010.00508.x
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Bibliographic Info

Article provided by Verein für Socialpolitik in its journal German Economic Review.

Volume (Year): 12 (2011)
Issue (Month): 1 (02)
Pages: 1-10

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Handle: RePEc:bla:germec:v:12:y:2011:i:1:p:1-10

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Find related papers by JEL classification:

• H00 - Public Economics - - General - - - General
• H11 - Public Economics - - Structure and Scope of Government - - - Structure and Scope of Government
• H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
• H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General
• H71 - Public Economics - - State and Local Government; Intergovernmental Relations - - - State and Local Taxation, Subsidies, and Revenue

References

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1. Wendelin Schnedler, 2001. "The Virtue of Being Underestimated: A Note on Discriminatory Contracts in Hidden Information Models," Bonn Econ Discussion Papers bgse18_2001, University of Bonn, Germany.
   
   • Schnedler, Wendelin, 2002. "The virtue of being underestimated: a note on discriminatory contracts in hidden information models," Economics Letters, Elsevier, vol. 75(2), pages 171-178, April.
   • Schnedler, Wendelin, 2001. "The Virtue of Being Underestimated: A Note on Discriminatory Contracts in Hidden Information Models," IZA Discussion Papers 342, Institute for the Study of Labor (IZA).
2. Thiele, Henrik & Wambach, Achim, 1999. "Wealth Effects in the Principal Agent Model," Journal of Economic Theory, Elsevier, vol. 89(2), pages 247-260, December.
3. Sliwka, Dirk, 2003. "On the Hidden Costs of Incentive Schemes," IZA Discussion Papers 844, Institute for the Study of Labor (IZA).
   
   • Dirk Sliwka, 2003. "On the Hidden Costs of Incentive Schemes," Bonn Econ Discussion Papers bgse12_2003, University of Bonn, Germany.
4. Friebel, Guido & Schnedler, Wendelin, 2007. "Team Governance: Empowerment or Hierarchical Control," IZA Discussion Papers 3143, Institute for the Study of Labor (IZA).
   
   • Friebel, Guido & Schnedler, Wendelin, 2011. "Team governance: Empowerment or hierarchical control," Journal of Economic Behavior & Organization, Elsevier, vol. 78(1), pages 1-13.
   • Friebel, Guido & Schnedler, Wendelin, 2011. "Team governance: Empowerment or hierarchical control," Journal of Economic Behavior & Organization, Elsevier, vol. 78(1-2), pages 1-13, April.
   • Guido Friebel & Wendelin Schnedler, 2007. "Team Governance: Empowerment or Hierarchical Control," Working Papers 0457, University of Heidelberg, Department of Economics, revised Oct 2007.
   • Friebel, Guido & Schnedler, Wendelin, 2007. "Team Governance: Empowerment or Hierarchical Control," CEPR Discussion Papers 6575, C.E.P.R. Discussion Papers.
   • Friebel, Guido & Schnedler, Wendelin, 2007. "Team Governance: Empowerment of Hierarchical Control," IDEI Working Papers 520, Institut d'Économie Industrielle (IDEI), Toulouse.
5. Schnedler, Wendelin & Vadovic, Radovan, 2007. "Legitimacy of Control," IZA Discussion Papers 3013, Institute for the Study of Labor (IZA).
   
   • Wendelin Schnedler & Radovan Vadovic, 2011. "Legitimacy of Control," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 20(4), pages 985-1009, December.
   • Wendelin Schnedler & Radovan Vadovic, 2007. "Legitimacy of Control," The Centre for Market and Public Organisation 07/178, Department of Economics, University of Bristol, UK.
   • Wendelin Schnedler & Radovan Vadovic, 2007. "Legitimacy of Control," Working Papers 0450, University of Heidelberg, Department of Economics, revised Aug 2007.
   • Schnedler, Wendelin & Vadovic, Radovan, 2007. "Legitimacy of Control," Sonderforschungsbereich 504 Publications 07-61, Sonderforschungsbereich 504, Universität Mannheim & Sonderforschungsbereich 504, University of Mannheim.
6. Armin Falk & Michael Kosfeld, . "The Hidden Costs of Control," IEW - Working Papers 250, Institute for Empirical Research in Economics - University of Zurich.
   
   • Michael Kosfeld & Armin Falk, 2006. "The Hidden Costs of Control," American Economic Review, American Economic Association, vol. 96(5), pages 1611-1630, December.
7. Amin H. Amershi & John S. Hughes, 1989. "Multiple Signals, Statistical Sufficiency, and Pareto Orderings of Best Agency Contracts," RAND Journal of Economics, The RAND Corporation, vol. 20(1), pages 102-112, Spring.
8. Bruno S. Frey & Reto Jegen, 2000. "Motivation Crowding Theory: A Survey of Empirical Evidence," CESifo Working Paper Series 245, CESifo Group Munich.

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