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Adding a Stick to the Carrot? The Interaction of Bonuses and Fines

  • Ernst Fehr
  • Klaus M. Schmidt

In this paper we report on a principal-agent experiment where the principal can choose whether to rely on an unenforcable bonus contract or to combine the bonus contract with a fine if the agent’s effort falls below a minimum standard. We show that most principals do not use the fine and that the pure bonus contract is more efficient than the combined contract. Our experiment suggests that principals who are less fair are more likely to choose a combined contract and less likely to actually pay the announced bonus. This offers a new explanation for why explicit and implicit incentives are substitutes rather than complements.

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Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 97 (2007)
Issue (Month): 2 (May)
Pages: 177-181

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Handle: RePEc:aea:aecrev:v:97:y:2007:i:2:p:177-181
Note: DOI: 10.1257/aer.97.2.177
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  1. Benabou, Roland & Tirole, Jean, 2005. "Incentives and Prosocial Behavior," IZA Discussion Papers 1695, Institute for the Study of Labor (IZA).
  2. Frey, Bruno S & Jegen, Reto, 2001. " Motivation Crowding Theory," Journal of Economic Surveys, Wiley Blackwell, vol. 15(5), pages 589-611, December.
  3. Uri Gneezy & Aldo Rustichini, 2000. "Pay Enough Or Don'T Pay At All," The Quarterly Journal of Economics, MIT Press, vol. 115(3), pages 791-810, August.
  4. E. Fehr & John A. List, . "The Hidden Costs and Returns of Incentives - Trust and Trustworthiness among CEOs," IEW - Working Papers 134, Institute for Empirical Research in Economics - University of Zurich.
  5. 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.
  6. Fehr, Ernst & Schmidt, Klaus M., 2004. "Fairness and Incentives in a Multi-Task Principal-Agent Model," Discussion Papers in Economics 335, University of Munich, Department of Economics.
  7. Aldo Rustichini & Uri Gneezy, 2000. "A fine is a price," Natural Field Experiments 00258, The Field Experiments Website.
  8. Ernst Fehr & Alexander Klein & Klaus M Schmidt, 2007. "Fairness and Contract Design," Econometrica, Econometric Society, vol. 75(1), pages 121-154, 01.
  9. Ernst Fehr & Bettina Rockenbach, 2003. "Detrimental effects of sanctions on human altruism," Microeconomics 0305007, EconWPA.
  10. Roland Benabou & Jean Tirole, 2003. "Intrinsic and Extrinsic Motivation," Review of Economic Studies, Wiley Blackwell, vol. 70(3), pages 489-520, 07.
  11. Bruno S. Frey, 1997. "Not Just for the Money," Books, Edward Elgar, number 1183.
  12. Armin Falk & Michael Kosfeld, . "The Hidden Costs of Control," IEW - Working Papers 250, Institute for Empirical Research in Economics - University of Zurich.
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