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Implicit vs. Explicit Incentives: Theory and a Case Study

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Author Info
Dominique Demougin ()
Oliver Fabel ()
Christian Thomann ()

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Abstract

We derive the optimal contract between a principal and a liquidity-constrained agent in a stochastically repeated environment. The contract comprises a court-enforceable explicit bonus rule and an implicit fixed salary promise that must be self-enforcing. Since the agent’s rent increases with bonus pay, the principal implements the maximum credible salary promise. Thus, the bonus increases while the salary promise and the agent’s effort decrease with a higher probability of premature contract termination. We subject this mechanism to econometric testing using personnel data of an insurance company. The empirical results strongly support our theoretical predictions.

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Publisher Info
Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number CESifo Working Paper No. 2645.

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Date of creation: 2009
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Handle: RePEc:ces:ceswps:_2645

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Related research
Keywords: implicit contract; explicit bonus pay; premature contract termination; compensation and productivity estimates;

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Find related papers by JEL classification:
J30 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - General
M50 - Business Administration and Business Economics; Marketing; Accounting - - Personnel Economics - - - General

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

  1. I. Theodossiou & M.J. White, 1998. "Does tenure affect earnings?," Journal of Economic Studies, Emerald Group Publishing, vol. 25(4), pages 328-343, September. [Downloadable!] (restricted)
  2. Robert Eisner & Robert H. Strotz, 1961. "Flight Insurance and the Theory of Choice," Journal of Political Economy, University of Chicago Press, vol. 69, pages 355. [Downloadable!] (restricted)
  3. Rachel M. Hayes & Scott Schaefer, 2000. "Implicit Contracts and the Explanatory Power of Top Executive Compensation for Future Performance," RAND Journal of Economics, The RAND Corporation, vol. 31(2), pages 273-293, Summer.
  4. Edward P. Lazear, 2000. "Performance Pay and Productivity," American Economic Review, American Economic Association, vol. 90(5), pages 1346-1361, December. [Downloadable!] (restricted)
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  5. Baker, George & Gibbons, Robert & Murphy, Kevin J, 1994. "Subjective Performance Measures in Optimal Incentive Contracts," The Quarterly Journal of Economics, MIT Press, vol. 109(4), pages 1125-56, November. [Downloadable!] (restricted)
    Other versions:
  6. Jonathan Levin, 2003. "Relational Incentive Contracts," American Economic Review, American Economic Association, vol. 93(3), pages 835-857, June. [Downloadable!]
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  7. J. David Cummins & Neil A. Doherty, 2006. "The Economics of Insurance Intermediaries," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 73(3), pages 359-396. [Downloadable!] (restricted)
  8. Rayton, Bruce A., 2003. "The residual claim of rank and file employees," Journal of Corporate Finance, Elsevier, vol. 9(1), pages 129-148, January. [Downloadable!] (restricted)
  9. Canice Prendergast, 1999. "The Provision of Incentives in Firms," Journal of Economic Literature, American Economic Association, vol. 37(1), pages 7-63, March. [Downloadable!] (restricted)
  10. R. Lynn Hannan & John H. Kagel & Donald V. Moser, 2002. "Partial Gift Exchange in an Experimental Labor Market: Impact of Subject Population Differences, Productivity Differences, and Effort Requests on Behavior," Journal of Labor Economics, University of Chicago Press, vol. 20(4), pages 923-951, October. [Downloadable!]
  11. Dirk Sliwka, 2007. "Trust as a Signal of a Social Norm and the Hidden Costs of Incentive Schemes," American Economic Review, American Economic Association, vol. 97(3), pages 999-1012, June. [Downloadable!]
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  1. Stergios Skaperdas, 2009. "The Costs of Organized Violence: A Review of the Evidence," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
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  2. Axel Dreher & Justina A.V. Fischer, 2009. "Government Decentralization as a Disincentive for Transnational Terror? An Empirical Analysis," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
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  3. Firouz Gahvari, 2009. "Friedman Rule in a Model with Endogenous Growth and Cash-in-advance Constraint," CESifo Working Paper Series CESifo Working Paper No. , CESifo Group Munich. [Downloadable!]
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