Discretionary rewards as a feedback mechanism

This paper studies the use of discretionary rewards in a finitely repeated principal-agent relationship with moral hazard. The key aspect is that rewards have informational content. When the principal obtains a private subjective signal about the agent's performance, she may pay discretionary bonuses to provide credible feedback to the agent. In accordance with the often observed compression of ratings, we show that in equilibrium the principal communicates the agent's interim performance imperfectly, i.e., she does not fully differentiate good and bad performance. Furthermore, we show that small rewards can have a large impact on the agent's effort, provided that the principal's stake in the project is small.

[1]  George P. Baker,et al.  Subjective Performance Measures in Optimal Incentive Contracts , 1993 .

[2]  William Fuchs,et al.  Contracting with Repeated Moral Hazard and Private Evaluations , 2006 .

[3]  J. Sobel,et al.  Equilibrium Selection in Signaling Games , 1987 .

[4]  E. Fehr,et al.  Reciprocity as a contract enforcement device: experimental evidence , 1997 .

[5]  J. Tirole,et al.  Intrinsic and Extrinsic Motivation , 2003 .

[6]  Alessandro Lizzeri,et al.  The Incentive Effects of Interim Performance Evaluations , 2002 .

[7]  Canice Prendergast.  The Provision of Incentives in Firms , 1999 .

[8]  J. Tirole,et al.  Self-Confidence and Personal Motivation , 2002 .

[9]  David M. Kreps,et al.  Rational cooperation in the finitely repeated prisoners' dilemma , 1982 .

[10]  Michael J. Gibbs.  AN ECONOMIC APPROACH TO PROCESS IN PAY AND PERFORMANCE APPRAISALS , 2001 .

[11]  David M. Kreps,et al.  Signaling Games and Stable Equilibria , 1987 .

[12]  Martin Shubik,et al.  The Interaction of Implicit and Explicit Contracts in Repeated Agency , 1988 .

[13]  Ernst Fehr,et al.  Reciprocity as a Contract Enforcement Device , 2001 .

[14]  B. Kőszegi.  EGO UTILITY, OVERCONFIDENCE, AND TASK CHOICE , 2006 .

[15]  Boyan Jovanovic.  Job Matching and the Theory of Turnover , 1979, Journal of Political Economy.

[16]  Akira Okada.  Perfect Bayesian Equilibrium and Sequential Equilibrium , 2011 .

[17]  David Pearce,et al.  The Interaction of Implicit and Explicit Contracts in Repeated Agency , 1998 .

[18]  B. Frey.  Not Just for the Money: An Economic Theory of Personal Motivation , 1998 .

[19]  E. Deci,et al.  A meta-analytic review of experiments examining the effects of extrinsic rewards on intrinsic motivation. , 1999, Psychological bulletin.

[20]  Navin Kartik,et al.  On Cheap Talk and Burned Money , 2005 .

[21]  Paul R. Milgrom,et al.  Economics, Organization and Management , 1992 .

[22]  J. Sobel,et al.  Strategic stability and uniqueness in signaling games , 1990 .

[23]  C. Bull.  The Existence of Self-Enforcing Implicit Contracts , 1987 .

[24]  B. Bernheim,et al.  A Theory of Conformity , 1994, Journal of Political Economy.

[25]  A note on cheap talk and burned money , 2007, J. Econ. Theory.

[26]  Cary L. Cooper,et al.  Work Psychology: Understanding Human Behaviour in the Workplace , 1991 .

[27]  Edward L. Deci,et al.  Intrinsic Motivation and Self-Determination in Human Behavior , 1975, Perspectives in Social Psychology.

[28]  J. D. Carrillo,et al.  Strategic Ignorance as a Self-Disciplining Device , 2000 .

[29]  J. Sobel,et al.  STRATEGIC INFORMATION TRANSMISSION , 1982 .

[30]  W. MacLeod,et al.  Implicit Contracts, Incentive Com-patibility, and Involuntary Unemployment , 1989 .

[31]  W. Bentley MacLeod,et al.  missions of CIRANO: to develop the scientific analysis of organizations and strategic behaviour. Les organisations-partenaires / The Partner Organizations , 2022 .

[32]  E. Vandamme.  Stability and perfection of nash equilibria , 1987 .

[33]  Oriol Carbonell-Nicolau.  Games and Economic Behavior , 2011 .

[34]  Nick Feltovich,et al.  Too Cool for School? Signaling and Countersignaling , 2001 .

[35]  W. MacLeod,et al.  On Optimal Contracting with Subjective Evaluation , 2001 .

[36]  David M. Kreps,et al.  Relational Incentive Contracts , 2003 .

[37]  Paul R. Milgrom,et al.  Good News and Bad News: Representation Theorems and Applications , 1981 .