Optimal Contracts for Long-Term Decisions and the Threat of Dismissal

This paper studies a simple agency model where an agent's decision can affect his or her own future payoffs as well as the principal's. The threat of dismissal becomes an important part of an incentive scheme even if the principal can use the performance-based wage contract. However, if the agent's future payoffs depend on the past realized performance, but not on the past decision directly, or if the agent is risk-neutral, it is not optimal to use the threat of dismissal. As the agent's discretion over his future payoffs increases, the principal relies more on the threat of dismissal but less on the wage contract.     

Accountability in an agency model: Project selection,effort incentives,and contract design*

We analyze an agency model of project choice and implementation where the agent is held accountable for his performance. We show that implementation of the ex ante efficient project may be impossible, irrespective of how the principal sets fixed wage and bonus rate. If it is possible, the principal may be forced to increase the bonus rate above the optimal project‐specific rate. The higher profit share compensates the agent for pressure he faces when he has to justify/explain his performance.     

A Mixed Contract with Alternative Performance Measures in a Multitask Agency

We compare the impact of two different mixed contracts on agent efforts when production depends on agent efforts at their own tasks as well as at helping others. The first contract combines compensation based on team output with that of a tournament where the bonus award is based on a ranking of individual output. The second contract also combines team output compensation with that of tournament except that the bonus award is based upon a relative ranking of an index constructed of alternative performance measures. We show that the latter contract can lead to higher levels of welfares than the former one. We also show that if the weights are properly constructed, the alternative contract can prompt agents into choosing first‐best levels of effort. Copyright © 2013 John Wiley & Sons, Ltd.     

Incorporating a “no claim bonus” in insurance agency contract

A bonus received by an agent from an insurer when the insured does not make a claim is called a “no claim bonus” (NCB). An NCB rewards the agent's risk‐management (RM) effort that reduces the probability that the insured suffers a loss. This paper designs an incentive compatible contract that induces the agent to choose an RM effort. If the agent's RM effort cost is lower than a threshold, feasible ranges of NCB and premium values exist such that the insurer can offer an incentive compatible agency contract with an NCB that is acceptable to the agent.     

Unpredictable times: the extent,characteristics and correlates of insecure hours of work in Britain

This article presents new British evidence that suggests that cutting working hours at short notice is twice as prevalent as zero-hours contracts and triple the number of employees are very anxious about unexpected changes to their hours of work. The pay of these employees tends to be lower, work intensity higher, line management support weaker and the threat of dismissal and job loss greater. In addition, the well-being of these employees is lower and they are less committed to the organisations that employ them. However, the prevalence of insecure working hours is reduced by workplace level employee involvement exercised individually or through collective representation.     

Peer Evaluation: Incentives and Coworker Relations

In many workplaces, coworkers have the best information about each other's efforts. This paper studies a principal who only observes the joint output by two limitedly liable agents, while agents receive signals about each other's effort levels. The principal attempts to exploit this information through peer evaluation; agents are asked to report their signal and may receive a bonus for being evaluated positively. Lying aversion ascertains that truthful evaluation is possible, while interpersonal relations between colleagues give an incentive to misreport. This paper shows that peer evaluation gives an incentive for effort, even when the evaluations are not truthful. The peer evaluation bonus is constrained by more intensive coworker relations. Still, the optimal contract always includes a peer evaluation bonus, sometimes complemented with a team bonus. Coworker relations have nonmonotonic effects on profits in the optimal contract.     

Effects of staff bonus systems on safety behaviors

Bonus systems are a common means in trying to motivate employees to perform well. However, there is still disagreement regarding the effects of bonus systems. Some theories even suggest that such systems could cause an increase in risk-behavior. This makes further research regarding bonus systems warranted, especially when applied in high-risk organizations. This study aims to explore potential effects on safety-related behavior associated with bonus systems currently used at Swedish nuclear power plants. Fifteen semi-structured interviews with employees were performed based on an eclectically composed framework from motivational and organizational theories. Results do not indicate any negative effects on safety-related behaviors, but rather that safety behaviors may be promoted insofar as bonus rewards are linked to performance goals concerning safety. Differences in bonus system design appeared to affect behavioral outcomes. The comparative and qualitative approach of this study contributes valuable information by highlighting the types of factors that may serve to stimulate greater incentive for employees to engage in safe behavior.     

Effects of employment protection on worker and job flows: Evidence from the 1990 Italian reform

This paper uses the Italian Social Security employer-employee panel to study the effects of the Italian reform of 1990 on worker and job flows. We exploit the fact that this reform increased unjust dismissal costs for businesses below 15 employees, while leaving dismissal costs unchanged for bigger businesses, to set up a natural experiment research design. We find that the increase in dismissal costs decreased accessions and separations for workers in small relative to large firms, especially in sectors with higher employment volatility, with a negligible impact on net employment. We also find some evidence suggesting that the reform reduced firms' entry rates and employment adjustments, but had no effect on exit rates.     

Trust in Agency

Existing models of the principal–agent relationship assume the agent works only under extrinsic incentives. However, many observed agency contracts take the form of a fixed payment. For such contracts to work, the principal must trust the agent to work in the absence of incentives. I show that agency fosters the advent of intrinsic motivation and trustworthy behavior. Three distinct motivational schemes are analyzed: norms, ethical standards, and altruism. I identify conditions under which these mechanisms arise and show how they promote trust. The analysis alters several important predictions of conventional models: (1) Better outcomes may ensue in highly uncertain environments; (2) the principal is better off the more the agent is risk averse; and (3) larger equilibrium extrinsic incentives need not be associated with larger effort or larger total surplus .     

Retracted: Effects of Anonymous Whistle‐Blowing and Perceived Reputation Threats on Investigations of Whistle‐Blowing Allegations by Audit Committee Members

A total of 83 experienced audit committee members participated in an experiment in which they evaluated the credibility of and allocated investigative resources towards a whistle‐blowing allegation of financial reporting malfeasance by corporate executive officers. We manipulated whether the whistle‐blowing allegation was made through anonymous or non‐anonymous channels and whether the allegation posed a relatively high or low threat to the personal reputation of the audit committee member who was charged with investigating the allegation. Results indicate that the participating audit committee members attributed lower credibility and allocated fewer investigatory resources when the whistle‐blowing report was received through an anonymous versus non‐anonymous channel, and when the allegation posed a relatively high versus low level of reputation threat. While the Sarbanes–Oxley Act of 2002 requires audit committees of publicly traded firms to provide an anonymous whistle‐blowing channel to employees, our findings suggest disturbing unintended consequences of such regulation; specifically, audit committee members might fail to sufficiently investigate whistle‐blowing allegations received through anonymous whistle‐blowing channels, particularly if the allegation poses a personal reputation threat.     

Altruism, redistribution and social insurance

The paper examines the influence of altruism on voluntary transfers and government redistribution in a simple model: two jobs of different productivity are assigned by chance to two individuals. Ex ante the individuals are identical, ex post they have different incomes. The first part of the paper examines voluntary transfers determined ex post or agreed upon ex ante in the absence of altruism. In the second part, the influence of altruism is examined. Altruism is modelled as a pure public good: the minimum consumption (or income, since there is only one consumption good). Both individuals can contribute to its provision, one person by earning wage income, the other by voluntary transfers. The ex ante solutions generally lead to higher expected welfare but create several incentive problems. Only lump-sum transfers are considered. Received: 28 February 1997 / Accepted: 31 January 2000     

Group versus Individual Performance Pay in Relational Employment Contracts when Workers are Envious

I compare group to individual performance pay when workers are envious and performance is nonverifiable. Avoiding payoff inequity, the group reward scheme is optimal as long as the firm faces no credibility problem. The individual reward scheme may, however, become superior albeit introducing the prospect of unequal pay. This is due to two reasons: Group incentives are relatively low‐powered compared to individual incentives, requiring higher incentive pay and impeding credibility of the firm. Moreover, with individual rewards, the firm benefits from the incentive‐strengthening effect of envy, allowing for yet smaller overall incentive pay and further softening the credibility constraint. I also show that contracts combining both individual and group rewards are often optimal, depending on the firm's credibility problem. These contracts include joint and relative performance pay schemes.     

Dynamic incentive contracts with termination threats

We consider a dynamic moral hazard model where the principal offers a series of short-run contracts. We study the optimal mix of two alternative instruments for incentive provision: a performance based wage (a “carrot”) and a termination threat (a “stick”). At any given point in time, these instruments are substitutes in the provision of incentives. We are particularly interested in the dynamic interaction of these two instruments. Both carrot and stick are used more intensively as the agent approaches the end of his finite life. The sharing of the surplus of the relationship plays a key role: a termination threat is included in the optimal contract if and only if the agent’s expected future gain from the relationship is sufficiently high, compared to the principal’s expected future gain. Also, a termination threat is more likely to be optimal if output depends more on “luck” than on effort, if the discount factor is high, or if the agent’s productivity is low. The model, provided that the optimal contract includes a termination threat, essentially provides an alternative explanation for upward-sloping wage profiles even in the absence of full-commitment.     

Incentive Contracting Under Limited Liability

We examine the nature of incentive schemes between the principal and the risk-neutral agent in the presence of the agent's limited liability and ex ante action choice. We consider alternative schemes when a simple rental contract is infeasible due to the limited liability of the agent and study the effectiveness of a performance bonus scheme in achieving the first-best outcome. We also discuss some implications of such schemes in real practices.     

Limited Liability and Bonus Contracts

This paper studies the nature of incentive contracts between a risk-neutral principal and a risk-neutral agent under the constraint that the agent's liability is limited. A necessary and sufficient condition is derived for the existence of a first-best contract under this constraint, and a bonus-based contract is shown to be the most efficient contractual form. Implications of bonus contracts are also discussed.     

Three characteristic functions and tentative remarks on credible threats

In this paper the α and β characteristic functions are reviewed and a new concept, the credible threat function, is introduced following some tentative remarks on the credibility of threats.     

Agency-Theory and Internal-Labor-Market Explanations of Bonus Payments: Empirical Evidence from Spanish Firms

This paper combines agency theory and internal-labor-market theories to explain the determinants of bonus payments among a large sample of top and middle managers from Spanish firms. A distinction is made between the decision whether to pay bonus or not and the size of the bonus. The empirical evidence confirms that the two decisions are determined by different factors. The results of the analysis show a trade-off between short-term and long-term incentives (bonuses and promotion opportunities) as well as differences in the pattern of compensation policies across economic sectors and functional areas inside the firm.     

On the impact of managerial bonus systems on firm profit and market competition: the cases of pure profit,sales, market share and relative profits compared

By designing remuneration schemes based on a bonus rewarding specific firm‐level outcomes, the owners/shareholders of a firm can manipulate the behavior of their managers. In practice, different bonus anchors take center stage: some are profit‐based, others use sales as the key yardstick and still different ones focus on relative performance vis‐à‐vis a peer group. In this paper, we focus on the impact of remuneration schemes on firm‐level profitability. The profit effect is investigated for (all possible combinations of) four bonus systems using delegation games. In the context of a linear Cournot model for two or three firms, we model a two‐ or three‐stage decision structure where, in the first stage (or first two stages), an owner decides on the bonus system for his manager and where, in the final stage, the manager takes the daily output decision for her firm. It appears that the bonus system based on relative (profits) performance is superior throughout. Copyright © 2008 John Wiley & Sons, Ltd.     

Experienced and Novice Investors: Does Environmental Information Influence Investment Allocation Decisions?

Economic Value Added (EVA) is a performance measure that is being used by an increasing number of companies, but academic research on EVA is limited. In addition, all prior empirical academic studies on EVA have used the firm as the unit of analysis. In this study, we examine the effect of EVA on the performance of individual managers. Specifically, we examine whether managers on EVA-based bonus plans outperform managers on traditional accounting-based bonus plans. We are able to test this because we have access to an EVA-focused company that has managers on both EVA and traditional bonus plans. Our results suggest that managers on EVA bonus plans who understand the EVA concept perform better than managers on traditional bonus plans. However, we find some evidence that the increase in performance results from increased consistency or congruence in the manager's evaluation–reward process rather than from superiority of EVA as a performance measure. Also, we find that the effect of EVA bonuses and EVA understanding differs depending on the area of the firm in which the manager is employed. This suggests that EVA may not be a universally appropriate base for reward systems. *Mohan Lal passed away 24 July 2002. This paper is dedicated to him.     

Directors' Pay and Turnover: An Application to a Sample of Large UK Firms

This paper examines the operation of the UK managerial labour market. We test the twin agency predictions that directors' pay is positively related to corporate performance and CEO turnover is negatively associated with firm profitability. We find that (i) the panel data econometric evidence reveals a significant and positive correlation between directors' pay, company performance and size, (ii) the CEO turnover model predicts a negative, and significant, association with pre-dated shareholder returns: the data is consistent with the view that CEOs are disciplined by the threat of dismissal, (iii) boardroom governance factors (e.g. proportion of non-executives and board size) are only of some importance in the CEO succession process.