Discretionary Bonuses as a Feedback Mechanism
AbstractThis paper studies the use of discretionary rewards in a finitely repeated principal-agent relationship with moral hazard. We show that the principal, when she obtains a private subjective signal about the agent’s performance, may pay discretionary bonuses to provide credible feedback to the agent. Conistent with the often observed compression of ratings, we show that in equilibrium the principal communicates the agent’s interim performance imperfectly, i.e. she does not fully di?erentiate good and bad performance. Furthermore, we show that small rewards can have a large impact on the agent’s effort provided that the principal’s stake in the project is small. Our analysis further reveals that, also in accordance with the empirical findings, the principal may ex ante prefer to choose a ’smoky’, rather than a fully transparent performance monitoring system, thereby acquiring an implicit commitment device to reward the agent through discretionary bonuses.
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Bibliographic InfoPaper provided by Center for Economic and Financial Research (CEFIR) in its series Working Papers with number w0088.
Length: 35 pages
Date of creation: Mar 2006
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discretionary rewards; feedback; self confidence; subjective performance; moral hazard; monitoring system;
Find related papers by JEL classification:
- D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
- J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
- M50 - Business Administration and Business Economics; Marketing; Accounting - - Personnel Economics - - - General
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