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You Don't Always Get What You Pay For


  • Wendelin Schnedler

    () (University of Heidelberg, Department of Economics)


Consider a principal-agent relationship in which more effort by the agent raises the likelihood of success. Does rewarding success, i.e., paying a bonus, increase effort in this case? I find that bonuses have not only an incentive but also an income effect. Overall, bonuses paid for success may well reduce effort and hence the probability of success. I also identify conditions under which the income effect dominates the incentive effect, and single out the hazard-rate of effort as a crucial determinant of this trade-off.

Suggested Citation

  • Wendelin Schnedler, 2007. "You Don't Always Get What You Pay For," Working Papers 0452, University of Heidelberg, Department of Economics, revised Sep 2007.
  • Handle: RePEc:awi:wpaper:0452

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    References listed on IDEAS

    1. Blundell, Richard & Macurdy, Thomas, 1999. "Labor supply: A review of alternative approaches," Handbook of Labor Economics,in: O. Ashenfelter & D. Card (ed.), Handbook of Labor Economics, edition 1, volume 3, chapter 27, pages 1559-1695 Elsevier.
    2. Grossman, Sanford J & Hart, Oliver D, 1983. "An Analysis of the Principal-Agent Problem," Econometrica, Econometric Society, vol. 51(1), pages 7-45, January.
    3. Ernst Fehr & Bettina Rockenbach, 2003. "Detrimental effects of sanctions on human altruism," Microeconomics 0305007, EconWPA.
    4. Bewley, Truman F, 1995. "A Depressed Labor Market as Explained by Participants," American Economic Review, American Economic Association, vol. 85(2), pages 250-254, May.
    5. Steven Shavell, 1979. "Risk Sharing and Incentives in the Principal and Agent Relationship," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 55-73, Spring.
    6. Michael Kosfeld & Armin Falk, 2006. "The Hidden Costs of Control," American Economic Review, American Economic Association, vol. 96(5), pages 1611-1630, December.
    7. Bengt Holmstrom, 1979. "Moral Hazard and Observability," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 74-91, Spring.
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    Cited by:

    1. Friebel, Guido & Schnedler, Wendelin, 2011. "Team governance: Empowerment or hierarchical control," Journal of Economic Behavior & Organization, Elsevier, vol. 78(1), pages 1-13.
    2. Schnedler, Wendelin & Vanberg, Christoph, 2014. "Playing ‘hard to get’: An economic rationale for crowding out of intrinsically motivated behavior," European Economic Review, Elsevier, vol. 68(C), pages 106-115.

    More about this item


    bonus; premium; incentives; income effect; moral hazard;

    JEL classification:

    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • J3 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs
    • M5 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics

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