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You Don't Always Get What You Pay For: Bonuses, Perceived Income, and Effort

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  • Wendelin Schnedler

Abstract

Consider a principal-agent relationship in which more effort by the agent raises the likelihood of success. This paper provides conditions such that no success bonus induces the agent to exert more effort and the optimal contract is independent of success. Moreover, success bonuses may even reduce effort and thus the probability of success. The reason is that bonuses increase the perceived income of the agent and can hence reduce his willingness to exert effort. This perceived income effect has to be weighed against the incentive effect of the bonus. The trade-off is determined by the marginal effect of effort on the success probability in relation to this probability itself (success hazard-rate of effort). The paper also discusses practical implications of the finding.

Suggested Citation

  • Wendelin Schnedler, 2009. "You Don't Always Get What You Pay For: Bonuses, Perceived Income, and Effort," The Centre for Market and Public Organisation 09/226, The Centre for Market and Public Organisation, University of Bristol, UK.
    • Handle: RePEc:bri:cmpowp:09/226
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    References listed on IDEAS

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    1. Thiele, Henrik & Wambach, Achim, 1999. "Wealth Effects in the Principal Agent Model," Journal of Economic Theory, Elsevier, vol. 89(2), pages 247-260, December.
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    Cited by:

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    2. Robert Butler & Liam J. A. Lenten & Patrick Massey, 2020. "Bonus incentives and team effort levels: Evidence from the “Field”," Scottish Journal of Political Economy, Scottish Economic Society, vol. 67(5), pages 539-550, November.
    3. Goytom Abraha Kahsay & Laura Mørch Andersen & Lars Gårn Hansen, 2014. "Price reactions when consumers are concerned about pro-social reputation," IFRO Working Paper 2014/09, University of Copenhagen, Department of Food and Resource Economics.

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    JEL classification:

    • H00 - Public Economics - - General - - - General
    • H11 - Public Economics - - Structure and Scope of Government - - - Structure and Scope of Government
    • H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General
    • H71 - Public Economics - - State and Local Government; Intergovernmental Relations - - - State and Local Taxation, Subsidies, and Revenue

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