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Discretionary Bonuses as a Feedback Mechanism

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Author Info

  • Anton Suvorov

    ()
    (CEFIR and New Economic School)

  • Jeroen van de Ven

    ()
    (University of Amsterdam and Utrecht School of Economics)

Abstract

This 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 Info

Paper provided by Center for Economic and Financial Research (CEFIR) in its series Working Papers with number w0088.

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Length: 35 pages
Date of creation: Mar 2006
Date of revision:
Handle: RePEc:cfr:cefirw:w0088

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Related research

Keywords: discretionary rewards; feedback; self confidence; subjective performance; moral hazard; monitoring system;

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References

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  1. Bull, Clive, 1987. "The Existence of Self-Enforcing Implicit Contracts," The Quarterly Journal of Economics, MIT Press, vol. 102(1), pages 147-59, February.
  2. Holmstrom, Bengt, 1999. "Managerial Incentive Problems: A Dynamic Perspective," Review of Economic Studies, Wiley Blackwell, vol. 66(1), pages 169-82, January.
  3. Bentley W. MacLeod, 2003. "Optimal Contracting with Subjective Evaluation," American Economic Review, American Economic Association, vol. 93(1), pages 216-240, March.
  4. W. Bentley MacLeod & James M. Malcomson, 1986. "Implicit Contracts, Incentive Compatibility, and Involuntary Unemployment," Working Papers 585, Queen's University, Department of Economics.
  5. Pearce, David G. & Stacchetti, Ennio, 1998. "The Interaction of Implicit and Explicit Contracts in Repeated Agency," Games and Economic Behavior, Elsevier, vol. 23(1), pages 75-96, April.
  6. Alessandro Lizzeri & Margaret A. Meyer & Nicola Persico, 2002. "The Incentive Effects of Interim Performance Evaluations," Penn CARESS Working Papers 592e9328faf6e775bf331e1c0, Penn Economics Department.
  7. Banks, Jeffrey S. & Sobel, Joel., 1985. "Equilibrium Selection in Signaling Games," Working Papers 565, California Institute of Technology, Division of the Humanities and Social Sciences.
  8. William Fuchs, 2005. "Contracting with Repeated Moral Hazard and Private Evaluations," 2005 Meeting Papers 431, Society for Economic Dynamics.
  9. Roland Bénabou & Jean Tirole, 2003. "Intrinsic and Extrinsic Motivation," Review of Economic Studies, Oxford University Press, vol. 70(3), pages 489-520.
  10. Jonathan Levin, 2000. "Relational Incentive Contracts," Working Papers 01002, Stanford University, Department of Economics.
  11. Canice Prendergast, 1999. "The Provision of Incentives in Firms," Journal of Economic Literature, American Economic Association, vol. 37(1), pages 7-63, March.
  12. Ernst Fehr & Simon Gachter & Georg Kirchsteiger, 2001. "Reciprocity as a Contract Enforcement Device," Levine's Working Paper Archive 563824000000000143, David K. Levine.
  13. George Baker & Robert Gibbons & Kevin J. Murphy, 1993. "Subjective Performance Measures in Optimal Incentive Contracts," NBER Working Papers 4480, National Bureau of Economic Research, Inc.
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Citations

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Cited by:
  1. Susanne Neckermann & Reto Cueni & Bruno S. Frey, 2010. "Awards at work," CREMA Working Paper Series 2010-01, Center for Research in Economics, Management and the Arts (CREMA).
    • Neckermann, Susanne & Cueni, Reto & Frey, Bruno S., 2012. "Awards at work," ZEW Discussion Papers 12-004, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.
    • Susanne Neckermann & Reto Cueni & Bruno S. Frey, 2009. "Awards At Work," CREMA Working Paper Series 2009-09, Center for Research in Economics, Management and the Arts (CREMA).
    • Susanne Neckermann & Reto Cueni & Bruno S. Frey, 2010. "Awards at work," IEW - Working Papers 411, Institute for Empirical Research in Economics - University of Zurich.
  2. Van den Steen, Eric, 2005. "Too Motivated?," Working papers 18180, Massachusetts Institute of Technology (MIT), Sloan School of Management.
  3. Bénabou, Roland & Tirole, Jean, 2004. "Incentives and Prosocial Behaviour," CEPR Discussion Papers 4633, C.E.P.R. Discussion Papers.
  4. Susanne Neckermann & Reto Cueni & Bruno S. Frey, 2009. "What is an Award Worth? An Econometric Assessment of the Impact of Awards on Employee Performance," CESifo Working Paper Series 2657, CESifo Group Munich.

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