Think Twice before Going for Incentives: Social Norms and the Principal’s Decision on Compensation Contracts

43 Pages Posted: 20 Aug 2012 Last revised: 26 Aug 2015

See all articles by Eddy Cardinaels

Eddy Cardinaels

KU Leuven; Tilburg University - Center and Faculty of Economics and Business Administration

Huaxiang Yin

Nanyang Technological University; Nanyang Technological University

Date Written: August 18, 2015

Abstract

Principals make decisions on various issues, ranging from contract design to control system implementation. Few studies examine the principal’s active role in these decisions. We experimentally investigate this role by studying how a principal’s choice for a truth-telling incentive contract, compared to a fixed-salary contract without truth-telling incentives, affects the honesty of their agents’ cost reporting. Results show that besides an incentive effect and a principal trust effect (Christ et al. [2012]), the active choice for incentives produces a negative “information leakage” effect. When principals use incentives, their choices not only incentivize truthful reporting and signal distrust, but they also leak important information about the social norm; namely, that other agents are likely to report dishonestly. Agents conform to this social norm by misrepresenting cost information more. Our results have important practical implications. Managers must recognize that their decisions can leak information to their agents, which may produce unanticipated consequences for the social norms of the organization.

Keywords: Incentive contract, information leakage effect, social norms, honesty

JEL Classification: C91, D83, M40

Suggested Citation

Cardinaels, Eddy and Yin, Huaxiang, Think Twice before Going for Incentives: Social Norms and the Principal’s Decision on Compensation Contracts (August 18, 2015). Available at SSRN: https://ssrn.com/abstract=2132472 or http://dx.doi.org/10.2139/ssrn.2132472

Eddy Cardinaels

KU Leuven ( email )

Naamsestraat 69
Leuven, B-3000
Belgium
+32 16326984 (Phone)

HOME PAGE: http://www.kuleuven.be/wieiswie/nl/person/00013472

Tilburg University - Center and Faculty of Economics and Business Administration ( email )

P.O. Box 90153
Warandelaan 2
Tilburg, 5000 LE
Netherlands
+31 134668231 (Phone)

HOME PAGE: http://www.tilburguniversity.edu/webwijs/show/?uid=e.cardinaels

Huaxiang Yin (Contact Author)

Nanyang Technological University ( email )

Nanyang Business School
Singapore, 639798
Singapore

Nanyang Technological University ( email )

S3-B1C-105, Nanyang Business School
Nanyang Technological University
Singapore, DC Singapore 639798
Singapore

HOME PAGE: http://www.nanyangbusinessschool.ntu.edu.sg/sprsv20/inter/MyProfileDetails.asp

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