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Distorted Performance Measures and Dynamic Incentives

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  • Oddvar M. Kaarbøe
  • Trond E. Olsen

Abstract

Incentive contracts must typically be based on performance measures that do not exactly match the agents' true contribution to the principals' objectives. Such misalignment may pose difficulties for effective incentive design. We analyze the extent to which implicit dynamic incentives, such as career concerns and ratchet effects, alleviate or aggfravate these problems. Our analysis demonstrates that the interplay between distorted performance measures and implicit incentives implies that career and ratchet effects have real effects in that stronger ratchet effects or greater distortion may increase optimal monetary incentives, and that distortion affects the optimality of different promotion rules.

Suggested Citation

  • Oddvar M. Kaarbøe & Trond E. Olsen, 2008. "Distorted Performance Measures and Dynamic Incentives," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 17(1), pages 149-183, March.
    • Handle: RePEc:bla:jemstr:v:17:y:2008:i:1:p:149-183
    DOI: 10.1111/j.1530-9134.2008.00174.x
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    References listed on IDEAS

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    11. Mathias Dewatripont & Ian Jewitt & Jean Tirole, 1999. "The Economics of Career Concerns, Part II: Application to Missions and Accountability of Government Agencies," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 66(1), pages 199-217.
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    Cited by:

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    2. S. Sinan Erzurumlu & Nitin Joglekar & Moren Lévesque & Fehmi Tanrisever, 2019. "How Angel Know-How Shapes Ownership Sharing in Stage-Based Contracts," Entrepreneurship Theory and Practice, , vol. 43(4), pages 773-801, July.
    3. Dietrichson, Jens, 2013. "Coordination Incentives, Performance Measurement and Resource Allocation in Public Sector Organizations," Working Papers 2013:26, Lund University, Department of Economics.
    4. Alberto Bayo-Moriones & Jose E. Galdon-Sanchez & Sara Martinez-de-Morentin, 2017. "Performance Measurement and Incentive Intensity," Journal of Labor Research, Springer, vol. 38(4), pages 496-546, December.
    5. Peter O. Christensen & Hans Frimor & Florin Şabac, 2020. "Real Incentive Effects of Soft Information," Contemporary Accounting Research, John Wiley & Sons, vol. 37(1), pages 514-541, March.

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    JEL classification:

    • J41 - Labor and Demographic Economics - - Particular Labor Markets - - - Labor Contracts

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