A Note on the Optimality of Bonus Pay
12 Pages Posted: 14 Mar 2000
Date Written: October 16, 1999
This note derives the optimal compensation contract with subjective evaluation when the principal and agent may not agree regarding performance. The optimal contract takes the form of a bonus payment whenever the principal believes performance is acceptable, but with the payment of a penalty by the principal whenever the agent disagrees with a negative evaluation by the principal. The efficiency of the relationship is increasing with the degree of correlation,a result that is consistent with the importance of trust for an efficient employment relationship.
JEL Classification: D82, J41
Suggested Citation: Suggested Citation