Can Second Chance Provisions Increase the Effectiveness of Penalty Contracts? Evidence from a Quasi-Field Experiment

36 Pages Posted: 20 Jan 2022

See all articles by Clara Xiaoling Chen

Clara Xiaoling Chen

University of Illinois at Urbana-Champaign - Department of Accountancy

Laura W. Wang

University of Illinois at Urbana-Champaign

Anne Wu

National Chengchi University (Taipei)

Steve Wu

Western University

Date Written: January 2022

Abstract

Companies often use penalty-based incentives in practice. Many of these companies give second chances to employees who have performed poorly in the past to improve performance. We predict that penalty contracts with second chance provisions will lead to higher employee performance relative to penalty contracts without such provisions. This is because the provision of second chances helps mitigate the negative impact of penalty contracts on the perceived fairness of the pay scheme. To test our hypothesis, we conduct a quasi-field experiment at two facilities of a manufacturing company for fourteen months. We implement a traditional penalty contract without a second chance provision in one facility and a similar penalty contract with a second chance provision in the other facility. We find results consistent with our theory. Our theory and results suggest that adding a second chance provision to penalty-based contracts can lead to performance benefits.

Keywords: penalty, second chance, fairness, performance

JEL Classification: M40, M41

Suggested Citation

Chen, Clara Xiaoling and Wang, Laura W. and Wu, Anne and Wu, Steve Yuching, Can Second Chance Provisions Increase the Effectiveness of Penalty Contracts? Evidence from a Quasi-Field Experiment (January 2022). Available at SSRN: https://ssrn.com/abstract=4012173 or http://dx.doi.org/10.2139/ssrn.4012173

Clara Xiaoling Chen (Contact Author)

University of Illinois at Urbana-Champaign - Department of Accountancy ( email )

1206 South Sixth Street
Champaign, IL 61820
United States

Laura W. Wang

University of Illinois at Urbana-Champaign ( email )

601 E John St
Champaign, IL Champaign 61820
United States
4696844455 (Phone)

Anne Wu

National Chengchi University (Taipei) ( email )

No. 64, Chih-Nan Road
Section 2
Wenshan, Taipei 11623
Taiwan

Steve Yuching Wu

Western University ( email )

1151 Richmond St
London, Ontario N6A 3K7
Canada

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