Team Incentives and Bonus Floors in Relational Contracts

Abstract

A common means of incorporating non-verifiable performance measures in compensation contracts is via bonus pools. We study a principal-multi-agent relational contracting model in which the optimal contract resembles a bonus pool. It specifies a minimum joint bonus floor the principal is required to pay out to the agents and gives the principal discretion to use non-verifiable performance measures to both increase the size of the pool and to allocate the pool to the agents. The joint bonus floor is useful because of its role in motivating the agents to mutually monitor each other (team incentives). In an extension section, we introduce a verifiable team performance measure, in part to establish the robustness of our results. In this case, the optimal contract either ignores the team measure completely or uses it to create a conditional bonus floor (a floor only when the team measure is high). There is a minimum precision requirement on the team measure that has to be satisfied before the team measure is used to motivate mutual monitoring.

Keywords: Bonus Pools, Relational Contracting, Non-verifiable Performance Measures, Team Incentives, Mutual Monitoring

JEL Classification: C70, D82, D86, M41