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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.

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File URL: http://www.uni-heidelberg.de/md/awi/forschung/dp452.pdf
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Paper provided by University of Heidelberg, Department of Economics in its series Working Papers with number 0452.

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Length: 7 pages
Date of creation: Sep 2007
Date of revision: Sep 2007
Handle: RePEc:awi:wpaper:0452
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  1. Richard Blundell & Thomas MaCurdy, 1998. "Labour supply: a review of alternative approaches," IFS Working Papers W98/18, Institute for Fiscal Studies.
  2. Ernst Fehr & Bettina Rockenbach, 2003. "Detrimental effects of sanctions on human altruism," Microeconomics 0305007, EconWPA.
  3. HOLMSTROM, Bengt, . "Moral hazard and observability," CORE Discussion Papers RP -379, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  4. 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.
  5. Sanford J Grossman & Oliver D Hart, 2001. "An Analysis of the Principal-Agent Problem," Levine's Working Paper Archive 391749000000000339, David K. Levine.
  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. Bewley, Truman F, 1995. "A Depressed Labor Market as Explained by Participants," American Economic Review, American Economic Association, vol. 85(2), pages 250-54, May.
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