You Don't Always Get What You Pay For: Bonuses, Perceived Income, and Effort

Wendelin Schnedler

The Centre for Market and Public Organisation from The Centre for Market and Public Organisation, University of Bristol, UK

Abstract: Consider a principal-agent relationship in which more effort by the agent raises the likelihood of success. This paper provides conditions such that no success bonus induces the agent to exert more effort and the optimal contract is independent of success. Moreover, success bonuses may even reduce effort and thus the probability of success. The reason is that bonuses increase the perceived income of the agent and can hence reduce his willingness to exert effort. This perceived income effect has to be weighed against the incentive effect of the bonus. The trade-off is determined by the marginal effect of effort on the success probability in relation to this probability itself (success hazard-rate of effort). The paper also discusses practical implications of the finding.

Keywords: bonus; premium; incentives; income effect; moral hazard (search for similar items in EconPapers)
JEL-codes: H00 H11 H20 H30 H71 (search for similar items in EconPapers)
Pages: 13 pages
Date: 2009-11
New Economics Papers: this item is included in nep-bec and nep-cta
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Related works:
Journal Article: You Don't Always Get What You Pay For: Bonuses, Perceived Income and Effort (2011)
Journal Article: You Don’t Always Get What You Pay For: Bonuses, Perceived Income and Effort (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:bri:cmpowp:09/226

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