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You Don't Always Get What You Pay For: Bonuses, Perceived Income and Effort

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  • Wendelin Schnedler

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.

(This abstract was borrowed from another version of this item.)

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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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References

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  1. Michael Kosfeld & Armin Falk, 2006. "The Hidden Costs of Control," American Economic Review, American Economic Association, vol. 96(5), pages 1611-1630, December.
  2. Guido Friebel & Wendelin Schnedler, 2007. "Team Governance: Empowerment or Hierarchical Control," Working Papers 0457, University of Heidelberg, Department of Economics, revised Oct 2007.
  3. Schnedler, Wendelin & Vadovic, Radovan, 2007. "Legitimacy of Control," IZA Discussion Papers 3013, Institute for the Study of Labor (IZA).
  4. Sliwka, Dirk, 2003. "On the Hidden Costs of Incentive Schemes," IZA Discussion Papers 844, Institute for the Study of Labor (IZA).
  5. 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).
  6. Thiele, Henrik & Wambach, Achim, 1999. "Wealth Effects in the Principal Agent Model," Journal of Economic Theory, Elsevier, vol. 89(2), pages 247-260, December.
  7. Bengt Holmstrom, 1979. "Moral Hazard and Observability," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 74-91, Spring.
  8. Bruno S. Frey & Reto Jegen, 2000. "Motivation Crowding Theory: A Survey of Empirical Evidence," CESifo Working Paper Series 245, CESifo Group Munich.
  9. 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.
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