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Optimal incentive mix of performance pay and efficiency wage

Author

Listed:
  • Anders Frederiksen

    (Aarhus School of Business, Center for Corporate Performance and IZA)

  • Elod Takats

    (Princeton University, Economics Department)

Abstract

Firms use a rich set of incentives including fixed wages, bonuses, threat of firing and promise of promotion. Yet, we do not have a theoretical understanding of how such a mix of incentives can arise. This paper aims to build a theoretical model which describes the incentive mix as the solution to an optimal contracting problem and provides broader testable implications. The basic model has a principal-agent relationship with unobservable effort. The integrative model includes the basic model and three building blocks: job-assignment, learning and human capital. The derived incentive mix is a consequence of the dual role of firing. It is both an incentive and a sorting decive. The model's predictions are tested on firm-level data from a large pharmaceutical company. The broader testable implications beyond the incentive mix are also confirmed by the data.

Suggested Citation

  • Anders Frederiksen & Elod Takats, 2004. "Optimal incentive mix of performance pay and efficiency wage," CERS-IE WORKING PAPERS 0418, Institute of Economics, Centre for Economic and Regional Studies.
    • Handle: RePEc:has:discpr:0418
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    File URL: http://www.econ.core.hu/doc/dp/dp/mtdp0418.pdf
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    References listed on IDEAS

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    Cited by:

    1. Csoka, Peter & Herings, P. Jean-Jacques & Koczy, Laszlo A., 2007. "Coherent measures of risk from a general equilibrium perspective," Journal of Banking & Finance, Elsevier, vol. 31(8), pages 2517-2534, August.
    2. András Simonovits, 2006. "Social Security Reform in the US: Lessons from Hungary," CERS-IE WORKING PAPERS 0602, Institute of Economics, Centre for Economic and Regional Studies, revised 24 Apr 2006.
    3. Iván Major, 2006. "Why do (or do not) banks share customer information? A comparison of mature private credit markets and markets in transition," CERS-IE WORKING PAPERS 0603, Institute of Economics, Centre for Economic and Regional Studies, revised 24 Apr 2006.
    4. Pouliakas, Konstantinos & Theodossiou, Ioannis, 2012. "Rewarding carrots and crippling sticks: Eliciting employee preferences for the optimal incentive design," Journal of Economic Psychology, Elsevier, vol. 33(6), pages 1247-1265.
    5. Pouliakas, Konstantinos & Theodossiou, Ioannis, 2009. "Rewarding Carrots & Crippling Sticks: Eliciting Employee Preferences for the Optimal Incentive Mix in Europe," MPRA Paper 14167, University Library of Munich, Germany.
    6. Gabor Virag, 2006. "Outside offers and bidding costs," CERS-IE WORKING PAPERS 0610, Institute of Economics, Centre for Economic and Regional Studies, revised 30 Aug 2006.

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