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Performance standards and optimal incentives

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  • Gutiérrez Arnaiz, Óscar
  • Salas-Fumás, Vicente

Abstract

This paper analyzes incentive design when agents' effort influences an uncertain output governed by a random process with semi-heavy tails. We find that the second-best incentive contract pays an output-increasing but bounded fee with a shape resembling performance-standard contracts that pay a fixed salary plus a capped bonus. In this contract, the pay-performance sensitivity around the standard increases (decreases) with the frequency with which performance is measured and with the kurtosis (volatility) parameter of the performance probability distribution. We also find that the optimal maximum bonus increases with volatility but decreases with the kurtosis parameter of the performance distribution.

Suggested Citation

  • Gutiérrez Arnaiz, Óscar & Salas-Fumás, Vicente, 2008. "Performance standards and optimal incentives," Journal of Accounting and Economics, Elsevier, vol. 45(1), pages 139-152, March.
    • Handle: RePEc:eee:jaecon:v:45:y:2008:i:1:p:139-152
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    Cited by:

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    2. Zabel, Astrid & Roe, Brian, 2009. "Optimal design of pro-conservation incentives," Ecological Economics, Elsevier, vol. 69(1), pages 126-134, November.
    3. Mark S. Carey & Bo Sun, 2015. "Risk Choices and Compensation Design," International Finance Discussion Papers 1130, Board of Governors of the Federal Reserve System (U.S.).
    4. Oxholm, Anne Sophie, 2016. "Physician Response to Target-Based Performance Payment," DaCHE discussion papers 2016:9, University of Southern Denmark, Dache - Danish Centre for Health Economics.
    5. Eric S. Chou & Chien-Lung Chen, 2015. "Can Agents Be Better Off with Pay Caps?," Scandinavian Journal of Economics, Wiley Blackwell, vol. 117(4), pages 1069-1090, October.
    6. Christian Lukas, 2010. "Reporting Frequency and Substitutable Tasks," Working Paper Series of the Department of Economics, University of Konstanz 2010-13, Department of Economics, University of Konstanz.
    7. Michal Matějka & Korok Ray, 2017. "Balancing difficulty of performance targets: theory and evidence," Review of Accounting Studies, Springer, vol. 22(4), pages 1666-1697, December.

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