IDEAS home Printed from
MyIDEAS: Login to save this paper or follow this series

Bonuses and Penalties as Equilibrium Incentive Devices, with Application to Manufacturing Systems

  • Olivella, P.
  • Aron, D.J.

Although psychologists view bonuses and penalties as very different means of providing incentives for workers, economists have had less success at making sense of the distinction. A rational worker should be indifferent as to whether a payment scheme is called a bonus or a penalty plan if the actual contingent pay stream is identical in the two cases. In this paper we provide a framework for understanding the difference between payment plans that are deemed to be penalty or bonus schemes, and derive implications for when such plans should be implemented as a function of observable features of the manufacturing and monitoring systems. We call a payment plan a "bonus" scheme if the high payment occurs infrequently in equilibrium; a payment scheme entails a possible "penalty" if the low wage occurs infrequently. The frequency of high and low payments is derived in equilibrium in a model with moral hazard and probabilistic monitoring. We focus on the role of commitment and the possibility of false positives in he monitoring technology. It is shown that when the firm can commit to a monitoring intensity the workers will (almost) always be diligent and a penalty scheme will be observed. When commitment is infeasible the optimal payment structure depends on whether the monitoring technology permits false positives. In the absence of false positives the workers will be observed to face a penalty scheme if found shirking, but when false positives are possible there will be considerable shirking by workers in equilibrium, and a bonus scheme will be observed. We then analyze the crucial features of our theoretical monitoring technology in he context of actual employment situations. We find that middle-management and other non-production jobs are appropriate for bonus-type incentives, whereas in unskilled jobs or aspects of highly skilled jobs that require diligence but not skill, such as arriving on the job on time, we predict penalty incentives. We argue t

(This abstract was borrowed from another version of this item.)

To our knowledge, this item is not available for download. To find whether it is available, there are three options:
1. Check below under "Related research" whether another version of this item is available online.
2. Check on the provider's web page whether it is in fact available.
3. Perform a search for a similarly titled item that would be available.

Paper provided by Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC) in its series UFAE and IAE Working Papers with number 153.91.

in new window

Length: 40 pages
Date of creation: 1991
Date of revision:
Handle: RePEc:aub:autbar:153.91
Contact details of provider: Postal: 08193, Bellaterra, Barcelona
Phone: 34 93 592 1203
Fax: +34 93 542-1223
Web page:

More information through EDIRC

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as in new window
  1. Chwe, Michael Suk-Young, 1990. "Why Were Workers Whipped? Pain in a Principal-Agent Model," Economic Journal, Royal Economic Society, vol. 100(403), pages 1109-21, December.
  2. Besanko, D. & Spulber, D.F., 1988. "Delegated Law Enforcement And Noncooperative Behavior," Papers m8820, Southern California - Department of Economics.
  3. Holmstrom, Bengt & Milgrom, Paul, 1987. "Aggregation and Linearity in the Provision of Intertemporal Incentives," Econometrica, Econometric Society, vol. 55(2), pages 303-28, March.
  4. Summers, Lawrence H. & Dickens, William T. & Katz, Lawrence F. & Lang, Kevin, 1989. "Employee Crime and the Monitoring Puzzle," Scholarly Articles 3645199, Harvard University Department of Economics.
  5. Olivella, P., 1989. "Information Control In Simultaneous Moves Games," UFAE and IAE Working Papers 133-90, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
  6. Fenoaltea, Stefano, 1984. "Slavery and Supervision in Comparative Perspective: A Model," The Journal of Economic History, Cambridge University Press, vol. 44(03), pages 635-668, September.
  7. repec:oup:restud:v:54:y:1987:i:2:p:265-77 is not listed on IDEAS
  8. Amos Tversky & Daniel Kahneman, 1979. "Prospect Theory: An Analysis of Decision under Risk," Levine's Working Paper Archive 7656, David K. Levine.
  9. Polinsky, Mitchell & Shavell, Steven, 1979. "The Optimal Tradeoff between the Probability and Magnitude of Fines," American Economic Review, American Economic Association, vol. 69(5), pages 880-91, December.
  10. Pau Olivella, 1989. "Information Structures and the Delegation of Monitoring," Discussion Papers 839, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  11. Milgrom, Paul & Roberts, John, 1990. "The Economics of Modern Manufacturing: Technology, Strategy, and Organization," American Economic Review, American Economic Association, vol. 80(3), pages 511-28, June.
  12. Nahum D. Melumad & Dilip Mookherjee, 1989. "Delegation as Commitment: The Case of Income Tax Audits," RAND Journal of Economics, The RAND Corporation, vol. 20(2), pages 139-163, Summer.
  13. Reinganum, Jennifer F. & Wilde, Louis L., 1985. "Income tax compliance in a principal-agent framework," Journal of Public Economics, Elsevier, vol. 26(1), pages 1-18, February.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:aub:autbar:153.91. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Xavier Vila)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.