Implicit vs. Explicit Incentives: Theory and a Case Study

Dominique Demougin (), Oliver Fabel () and Christian Thomann ()

No CESifo Working Paper No. 2645, CESifo Working Paper Series from CESifo Group Munich

Abstract: We derive the optimal contract between a principal and a liquidity-constrained agent in a stochastically repeated environment. The contract comprises a court-enforceable explicit bonus rule and an implicit fixed salary promise that must be self-enforcing. Since the agent’s rent increases with bonus pay, the principal implements the maximum credible salary promise. Thus, the bonus increases while the salary promise and the agent’s effort decrease with a higher probability of premature contract termination. We subject this mechanism to econometric testing using personnel data of an insurance company. The empirical results strongly support our theoretical predictions.

Keywords: implicit contract; explicit bonus pay; premature contract termination; compensation and productivity estimates (search for similar items in EconPapers)
JEL-codes: J30 M50 (search for similar items in EconPapers)
Date: 2009
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