Costly Rewards and Punishments

Lee Frances Z. Xu ()
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Lee Frances Z. Xu: Quinlan School of Business, Loyola University of Chicago, 16 E Pearson St, Chicago, IL 60611, USA

The B.E. Journal of Theoretical Economics, 2020, vol. 20, issue 1, 17

Abstract: To punish an agent, the principal often incurs costs. I study a principal’s least costly reward and punishment scheme for an agent whose effort the principal cannot observe. I find the principal’s cost is sometimes minimized by using both costly rewards and costly punishments because (1) the agent has an outside option, or (2) a principal without commitment ability repeatedly interacts with the agent. I also find that when an agent’s effort is better at increasing the probability of a good outcome for the principal, the agent’s payoff may decrease, because the principal replaces rewards with punishments.

Keywords: costly punishment; principal-agent; moral hazard; outside option; credibility (search for similar items in EconPapers)
JEL-codes: D23 D86 L20 (search for similar items in EconPapers)
Date: 2020
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DOI: 10.1515/bejte-2018-0131

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