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The Nexus between Contract Duration and the Use of Formal and Informal Incentive Pay

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  • Dominique Demougin
  • Oliver Fabel

Abstract

We investigate a firm's choice of formal and informal effort incentives in a repeated game setting with undistorted signaling and liquidity‐constrained agents. The model allows for a simple geometric representation of credibility and incentive‐feasibility effects on optimal contract design. If credibility constitutes a binding constraint, explicit, i.e. enforceable, performance pay and discretionary salary promises are unambiguous substitutes and higher employee performance is associated with lower‐powered bonus pay. Using personnel data from an insurance company, we show that the model's predictions regarding the mediating role of expected contract duration on these relationships are consistent with remuneration practices.

Suggested Citation

  • Dominique Demougin & Oliver Fabel, 2019. "The Nexus between Contract Duration and the Use of Formal and Informal Incentive Pay," LABOUR, CEIS, vol. 33(3), pages 351-370, September.
    • Handle: RePEc:bla:labour:v:33:y:2019:i:3:p:351-370
    DOI: 10.1111/labr.12151
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    Cited by:

    1. Bruno Deffains & Dominique Demougin, 2023. "Capitation taxes and the regulation of professional services," European Journal of Law and Economics, Springer, vol. 55(2), pages 167-193, April.

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