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Performance standards and optimal incentives

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  • Gutiérrez Arnaiz, Óscar
  • Salas-Fumás, Vicente
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    Abstract

    This paper analyzes incentive design when agents' effort influences an uncertain output governed by a random process with semi-heavy tails. We find that the second-best incentive contract pays an output-increasing but bounded fee with a shape resembling performance-standard contracts that pay a fixed salary plus a capped bonus. In this contract, the pay-performance sensitivity around the standard increases (decreases) with the frequency with which performance is measured and with the kurtosis (volatility) parameter of the performance probability distribution. We also find that the optimal maximum bonus increases with volatility but decreases with the kurtosis parameter of the performance distribution.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Accounting and Economics.

    Volume (Year): 45 (2008)
    Issue (Month): 1 (March)
    Pages: 139-152

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    Handle: RePEc:eee:jaecon:v:45:y:2008:i:1:p:139-152

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    Web page: http://www.elsevier.com/locate/jae

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    References

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    1. Healy, Paul M., 1985. "The effect of bonus schemes on accounting decisions," Journal of Accounting and Economics, Elsevier, vol. 7(1-3), pages 85-107, April.
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    17. Murphy, Kevin J., 2000. "Performance standards in incentive contracts," Journal of Accounting and Economics, Elsevier, vol. 30(3), pages 245-278, December.
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    Cited by:
    1. Zabel, Astrid & Roe, Brian, 2009. "Optimal design of pro-conservation incentives," Ecological Economics, Elsevier, vol. 69(1), pages 126-134, November.

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