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A Note on the Optimality of Bonus Pay

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  • W Bentley Macleod

Abstract

This note derives the optimal compensation contract with subjective evaluation when the principal and agent may not agree regarding performance. The optimal contract takes the form of a bonus payment whenever the principal believes performance is acceptable, but with the payment of a penalty by the principal whenever the agent disagrees with a negative evaluation of the principal. The efficiency of the relationship is increasing with the degree of correlation, a result that is consistent with the importance of trust for an efficient employment relationship.

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File URL: http://socserv.mcmaster.ca/econ/rsrch/papers/CILN/cilnwp41.pdf
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Paper provided by McMaster University in its series Canadian International Labour Network Working Papers with number 41.

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Length: 12 pages
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Handle: RePEc:mcm:cilnwp:41

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  1. 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.
  2. Myerson, Roger B, 1979. "Incentive Compatibility and the Bargaining Problem," Econometrica, Econometric Society, vol. 47(1), pages 61-73, January.
  3. d'Aspremont, Claude & Gerard-Varet, Louis-Andre, 1979. "Incentives and incomplete information," Journal of Public Economics, Elsevier, vol. 11(1), pages 25-45, February.
  4. Theodore Groves & John Ledyard, 1976. "Optimal Allocation of Public Goods: A Solution to the 'Free Rider Problem'," Discussion Papers 144, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  5. Canice Prendergast & Robert H. Topel, 1993. "Favoritism in Organizations," NBER Working Papers 4427, National Bureau of Economic Research, Inc.
  6. Carmichael, H Lorne, 1983. "The Agent-Agents Problem: Payment by Relative Output," Journal of Labor Economics, University of Chicago Press, vol. 1(1), pages 50-65, January.
  7. Shapiro, Carl & Stiglitz, Joseph E, 1984. "Equilibrium Unemployment as a Worker Discipline Device," American Economic Review, American Economic Association, vol. 74(3), pages 433-44, June.
  8. Bull, Clive, 1987. "The Existence of Self-Enforcing Implicit Contracts," The Quarterly Journal of Economics, MIT Press, vol. 102(1), pages 147-59, February.
  9. 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.
  10. Canice Prendergast, 1999. "The Provision of Incentives in Firms," Journal of Economic Literature, American Economic Association, vol. 37(1), pages 7-63, March.
  11. Fudenberg, Drew & Maskin, Eric, 1986. "The Folk Theorem in Repeated Games with Discounting or with Incomplete Information," Econometrica, Econometric Society, vol. 54(3), pages 533-54, May.
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