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Adding a stick to the carrot? The interaction of bonuses and fines

  • Fehr, Ernst
  • Schmidt, Klaus M.

In this paper we report on a principal-agent experiment where the principal can choose whether to rely on an unenforcable bonus contract or to combine the bonus contract with a fine if the agent’s effort falls below a minimum standard. We show that most principals do not use the fine and that the pure bonus contract is more efficient than the combined contract. Our experiment suggests that principals who are less fair are more likely to choose a combined contract and less likely to actually pay the announced bonus. This offers a new explanation for why explicit and implicit incentives are substitutes rather than complements.

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Paper provided by University of Munich, Department of Economics in its series Munich Reprints in Economics with number 20654.

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Date of creation: 2007
Date of revision:
Publication status: Published in American Economic Review 2 97(2007): pp. 177-181
Handle: RePEc:lmu:muenar:20654
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  1. Fehr, Ernst & Klein, Alexander & Schmidt, Klaus M., 2007. "Fairness and contract design," Munich Reprints in Economics 20618, University of Munich, Department of Economics.
  2. Frey, Bruno S & Jegen, Reto, 2001. " Motivation Crowding Theory," Journal of Economic Surveys, Wiley Blackwell, vol. 15(5), pages 589-611, December.
  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. Roland Bénabou & Jean Tirole, 2004. "Incentives and Prosocial Behavior," Working Papers 137, Princeton University, Woodrow Wilson School of Public and International Affairs, Discussion Papers in Economics..
  5. Fehr, Ernst & Schmidt, Klaus M., 2004. "Fairness and incentives in a multi-task principal-agent model," Munich Reprints in Economics 20657, University of Munich, Department of Economics.
  6. Roland Benabou & Jean Tirole, 2003. "Intrinsic and Extrinsic Motivation," Review of Economic Studies, Wiley Blackwell, vol. 70(3), pages 489-520, 07.
  7. Aldo Rustichini & Uri Gneezy, 2000. "A fine is a price," Natural Field Experiments 00258, The Field Experiments Website.
  8. Ernst Fehr & Bettina Rockenbach, 2003. "Detrimental effects of sanctions on human altruism," Microeconomics 0305007, EconWPA.
  9. Dirk Sliwka, 2007. "Trust as a Signal of a Social Norm and the Hidden Costs of Incentive Schemes," American Economic Review, American Economic Association, vol. 97(3), pages 999-1012, June.
  10. Ernst Fehr & John A. List, 2004. "The Hidden Costs and Returns of Incentives-Trust and Trustworthiness Among CEOs," Journal of the European Economic Association, MIT Press, vol. 2(5), pages 743-771, 09.
  11. Uri Gneezy & Aldo Rustichini, 2000. "Pay Enough Or Don'T Pay At All," The Quarterly Journal of Economics, MIT Press, vol. 115(3), pages 791-810, August.
  12. Bruno S. Frey, 1997. "Not Just for the Money," Books, Edward Elgar, number 1183, December.
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