Does Bonus Cap Curb Risk Taking? An Experimental Study of Relative Performance Pay and Bonus Regulation

Abstract

We conducted a lab experiment with 253 participants to examine how constraints on bonus akin to bonus regulations, such as bonus cap and malus, could affect individuals’ risk-taking in the presence of relative performance pay. Participants took greater risks when bonus was linked to investment performance relative to that of their peers (relative performance pay) than when it depended on their own performance only. In the absence of relative performance pay, bonus cap and malus reduced risk-taking. With relative performance pay, the risk-mitigating effects of bonus cap and malus were significantly weakened; but participants took less risk when bonus was made conditional on their team avoiding a loss.

Keywords: Bonus cap, malus, bonus regulation, risk choice

JEL Classification: C91, G28, G40, J31, J33, M52