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Adding a Stick to the Carrot? The Interaction of Bonuses and Fines

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  • Fehr, Ernst
  • Schmidt, Klaus M.

Abstract

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.

Suggested Citation

  • Fehr, Ernst & Schmidt, Klaus M., 2007. "Adding a Stick to the Carrot? The Interaction of Bonuses and Fines," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 197, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
    • Handle: RePEc:trf:wpaper:197
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    File URL: https://epub.ub.uni-muenchen.de/13355/1/197.pdf
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    References listed on IDEAS

    as
    1. Gneezy, Uri & Rustichini, Aldo, 2000. "A Fine is a Price," The Journal of Legal Studies, University of Chicago Press, vol. 29(1), pages 1-17, January.
    2. Uri Gneezy & Aldo Rustichini, 2000. "Pay Enough or Don't Pay at All," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 115(3), pages 791-810.
    3. Jean Tirole & Roland Bénabou, 2006. "Incentives and Prosocial Behavior," American Economic Review, American Economic Association, vol. 96(5), pages 1652-1678, December.
    4. Ernst Fehr & Klaus M. Schmidt, 2004. "Fairness and Incentives in a Multi‐task Principal–Agent Model," Scandinavian Journal of Economics, Wiley Blackwell, vol. 106(3), pages 453-474, October.
    5. Ernst Fehr & Alexander Klein & Klaus M Schmidt, 2007. "Fairness and Contract Design," Econometrica, Econometric Society, vol. 75(1), pages 121-154, January.
    6. Bruno S. Frey, 1997. "Not Just for the Money," Books, Edward Elgar Publishing, number 1183.
    7. 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.
    8. Ernst Fehr & Bettina Rockenbach, 2003. "Detrimental effects of sanctions on human altruism," Nature, Nature, vol. 422(6928), pages 137-140, March.
    9. 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, September.
    10. Bruno S. Frey & Reto Jegen, 2001. "Motivation Crowding Theory," Journal of Economic Surveys, Wiley Blackwell, vol. 15(5), pages 589-611, December.
    11. Roland Bénabou & Jean Tirole, 2003. "Intrinsic and Extrinsic Motivation," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 70(3), pages 489-520.
    12. Michael Kosfeld & Armin Falk, 2006. "The Hidden Costs of Control," American Economic Review, American Economic Association, vol. 96(5), pages 1611-1630, December.
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    More about this item

    Keywords

    moral hazard; bonus contract; implicit incentives; fairness; incentives;
    All these keywords.

    JEL classification:

    • C7 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory
    • C9 - Mathematical and Quantitative Methods - - Design of Experiments
    • J3 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs

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