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You Don't Always Get What You Pay For

  • Schnedler, Wendelin

    ()

    (University of Paderborn)

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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Paper provided by Institute for the Study of Labor (IZA) in its series IZA Discussion Papers with number 3077.

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Length: 9 pages
Date of creation: Sep 2007
Date of revision:
Publication status: published as ' You Don't Always Get What You Pay For: Bonuses, Perceived Income and Effort ' in: German Economic Review, 2011, 12 (1), 1 - 10
Handle: RePEc:iza:izadps:dp3077
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  1. 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.
  2. Bengt Holmstrom, 1979. "Moral Hazard and Observability," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 74-91, Spring.
  3. Michael Kosfeld & Armin Falk, 2006. "The Hidden Costs of Control," American Economic Review, American Economic Association, vol. 96(5), pages 1611-1630, December.
  4. Grossman, Sanford J & Hart, Oliver D, 1983. "An Analysis of the Principal-Agent Problem," Econometrica, Econometric Society, vol. 51(1), pages 7-45, January.
  5. 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.
  6. Ernst Fehr & Bettina Rockenbach, 2003. "Detrimental effects of sanctions on human altruism," Microeconomics 0305007, EconWPA.
  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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