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Distorted Performance Measures and Dynamic Incentives

  • Oddvar M. Kaarbøe
  • Trond E. Olsen

"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." Copyright 2008 Blackwell Publishing.

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Article provided by Wiley Blackwell in its journal Journal of Economics & Management Strategy.

Volume (Year): 17 (2008)
Issue (Month): 1 (03)
Pages: 149-183

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Handle: RePEc:bla:jemstr:v:17:y:2008:i:1:p:149-183
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  1. Meyer, M.A. & Olsen, T.E. & Torsvik, G., 1995. "Limited Intertemporal Commitment and Job Design," Economics Papers 102, Economics Group, Nuffield College, University of Oxford.
  2. Holmstrom, Bengt & Milgrom, Paul, 1987. "Aggregation and Linearity in the Provision of Intertemporal Incentives," Econometrica, Econometric Society, vol. 55(2), pages 303-28, March.
  3. Gibbons, Robert & Murphy, Kevin J, 1992. "Optimal Incentive Contracts in the Presence of Career Concerns: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 100(3), pages 468-505, June.
  4. George Baker, 2002. "Distortion and Risk in Optimal Incentive Contracts," Journal of Human Resources, University of Wisconsin Press, vol. 37(4), pages 728-751.
  5. Mathias Dewatripont & Ian Jewitt & Jean Tirole, 1999. "The economics of career concerns: part 2 :application to missions and accountability of government agencies," ULB Institutional Repository 2013/9641, ULB -- Universite Libre de Bruxelles.
  6. Meyer, Margaret A & Vickers, John, 1997. "Performance Comparisons and Dynamic Incentives," Journal of Political Economy, University of Chicago Press, vol. 105(3), pages 547-81, June.
  7. Wendelin Schnedler, 2003. "On the Prudence of Rewarding A While Hoping for B," The Centre for Market and Public Organisation 03/067, Department of Economics, University of Bristol, UK.
  8. Robert Gibbons, 1986. "Piece-Rate Incentive Schemes," Working papers 424, Massachusetts Institute of Technology (MIT), Department of Economics.
  9. Baker, George P, 1992. "Incentive Contracts and Performance Measurement," Journal of Political Economy, University of Chicago Press, vol. 100(3), pages 598-614, June.
  10. Fama, Eugene F, 1980. "Agency Problems and the Theory of the Firm," Journal of Political Economy, University of Chicago Press, vol. 88(2), pages 288-307, April.
  11. Holmstrom, Bengt & Milgrom, Paul, 1991. "Multitask Principal-Agent Analyses: Incentive Contracts, Asset Ownership, and Job Design," Journal of Law, Economics and Organization, Oxford University Press, vol. 7(0), pages 24-52, Special I.
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