You Don't Always Get What You Pay For

9 Pages Posted: 3 Nov 2007

See all articles by Wendelin Schnedler

Wendelin Schnedler

University of Paderborn - Department of Management; IZA Institute of Labor Economics; University of Bristol - Leverhulme Centre for Market and Public Organisation (CMPO)

Date Written: September 2007

Abstract

Consider a principal-agent relationship in which more effort by the agent raises the likelihood of success. Does rewarding success, i.e., paying a bonus, increase effort in this case? I find that bonuses have not only an incentive but also an income effect. Overall, bonuses paid for success may well reduce effort and hence the probability of success. I also identify conditions under which the income effect dominates the incentive effect, and single out the hazard-rate of effort as a crucial determinant of this trade-off.

Keywords: bonus, premium, incentives, income effect, moral hazard

JEL Classification: D8, J3, M5

Suggested Citation

Schnedler, Wendelin, You Don't Always Get What You Pay For (September 2007). IZA Discussion Paper No. 3077, Available at SSRN: https://ssrn.com/abstract=1026898 or http://dx.doi.org/10.2139/ssrn.1026898

Wendelin Schnedler (Contact Author)

University of Paderborn - Department of Management ( email )

Warburger Str. 100
D-33098 Paderborn
Germany

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

University of Bristol - Leverhulme Centre for Market and Public Organisation (CMPO) ( email )

12 Priory Road
Bristol BS8 1TN
United Kingdom

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