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Bonus and Penalty Schemes as Equilibrium Incentive Devices, with Application to Manufacturing Systems

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  • Aron, Debra J
  • Olivella, Pau

Abstract

This article reconciles the psychological notion of bonuses and penalties as incentive devices with an economic view of incentives. An objective definition of bonus and penalty schemes is presented and shown to correspond to equilibrium in a model of moral hazard and probabilistic monitoring. The model implies that middle-management and other nonproduction jobs are appropriate for bonus-type incentive contracts, whereas in either unskilled jobs or aspects of highly skilled jobs that require diligence but no skill, penalty incentive schemes are predicted. We argue that our model illuminates an internal contradiction in the prospect theory of Kahneman and Tversky. We also argue that Japanese manufacturing systems have inherent incentive properties that elicit a high level of diligence from factory workers. Copyright 1994 by Oxford University Press.

Suggested Citation

  • Aron, Debra J & Olivella, Pau, 1994. "Bonus and Penalty Schemes as Equilibrium Incentive Devices, with Application to Manufacturing Systems," Journal of Law, Economics, and Organization, Oxford University Press, vol. 10(1), pages 1-34, April.
  • Handle: RePEc:oup:jleorg:v:10:y:1994:i:1:p:1-34
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    Cited by:

    1. Marchegiani, Lucia & Reggiani, Tommaso & Rizzolli, Matteo, 2016. "Loss averse agents and lenient supervisors in performance appraisal," Journal of Economic Behavior & Organization, Elsevier, vol. 131(PA), pages 183-197.
    2. David A. Miller & Kareen Rozen, 2011. "Optimally Empty Promises and Endogenous Supervision," Cowles Foundation Discussion Papers 1823, Cowles Foundation for Research in Economics, Yale University, revised Jun 2012.
    3. Lucia Marchegiani & Tommaso Reggiani & Matteo Rizzolli, 2013. "Severity vs. Leniency Bias in Performance Appraisal: Experimental evidence," BEMPS - Bozen Economics & Management Paper Series BEMPS01, Faculty of Economics and Management at the Free University of Bozen.
    4. Inés Macho-Stadler & David Pérez-Castrillo, 2016. "Moral Hazard: Base Models and Two Extensions," Working Papers 883, Barcelona Graduate School of Economics.
    5. Joaquim Vergés, 2010. "Incentive schemes for executive officers when forecasts matter," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 31(5), pages 339-352.
    6. repec:spr:joptap:v::y::i::d:10.1007_s10957-018-1273-x is not listed on IDEAS

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