A Note on the Optimality of Bonus Pay
This note derives the optimal compensation contract with subjective evaluation when the principal and agent may not agree regarding performance. The optimal contract takes the form of a bonus payment whenever the principal believes performance is acceptable, but with the payment of a penalty by the principal whenever the agent disagrees with a negative evaluation of the principal. The efficiency of the relationship is increasing with the degree of correlation, a result that is consistent with the importance of trust for an efficient employment relationship.
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