Performance Thresholds in Managerial Incentive Contracts
Performance thresholds are commonly used in executive compensation contracts. We examine the contractual nonlinearity associated with performance thresholds and its incentive implications. Incorporating a performance threshold into a standard principal-agent model of a linear contract, we show that pay schemes using a performance threshold are optimal. By truncating a linear scheme at poor performance, the threshold mitigates agency costs associated with the downside risk of production. Examining CEO compensation data, we find evidence of the role of performance thresholds. As a consequence of under-threshold performance, the tobit estimator is shown to increase pay-performance sensitivity, notably improving upon the standard OLS estimator.
If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.