Implicit vs. Explicit Incentives: Theory and a Case Study
EBS Universität für Wirtschaft und Recht - EBS Business School - Department of Governance & Economics; CESifo (Center for Economic Studies and Ifo Institute for Economic Research)
Chair for International Personnel Management, Institute of Business Administration, Faculty of Economics and Business, University of Vienna
Christian J. Thomann
Leibniz University Hannover
CESifo Working Paper Series No. 2645
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.
Number of Pages in PDF File: 40
Keywords: implicit contract, explicit bonus pay, premature contract termination, compensation and productivity estimates
JEL Classification: J3, M5working papers series
Date posted: May 19, 2009
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