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Implicit vs. Explicit Incentives: Theory and a Case Study

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Listed:
  • Dominique Demougin
  • Oliver Fabel
  • Christian Thomann

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.

Suggested Citation

  • Dominique Demougin & Oliver Fabel & Christian Thomann, 2009. "Implicit vs. Explicit Incentives: Theory and a Case Study," CESifo Working Paper Series 2645, CESifo.
    • Handle: RePEc:ces:ceswps:_2645
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    References listed on IDEAS

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    Cited by:

    1. Michael Funke & Marc Gronwald, 2009. "A Convex Hull Approach to Counterfactual Analysis of Trade Openness and Growth," CESifo Working Paper Series 2692, CESifo.
    2. Jörg Budde & Matthias Kräkel, 2011. "Limited liability and the risk–incentive relationship," Journal of Economics, Springer, vol. 102(2), pages 97-110, March.

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    More about this item

    Keywords

    implicit contract; explicit bonus pay; premature contract termination; compensation and productivity estimates;
    All these keywords.

    JEL classification:

    • J30 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - General
    • M50 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics - - - General

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