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You Don't Always Get What You Pay For

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  • Schnedler, Wendelin

    (University of Paderborn)

Abstract

Consider a principal-agent relationship in which more effort by the agent raises the likelihood of success. Does rewarding success, i.e., paying a bonus, increase effort in this case? I find that bonuses have not only an incentive but also an income effect. Overall, bonuses paid for success may well reduce effort and hence the probability of success. I also identify conditions under which the income effect dominates the incentive effect, and single out the hazard-rate of effort as a crucial determinant of this trade-off.

Suggested Citation

  • Schnedler, Wendelin, 2007. "You Don't Always Get What You Pay For," IZA Discussion Papers 3077, Institute of Labor Economics (IZA).
    • Handle: RePEc:iza:izadps:dp3077
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    References listed on IDEAS

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    More about this item

    Keywords

    moral hazard; bonus; premium; incentives; income effect;
    All these keywords.

    JEL classification:

    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • J3 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs
    • M5 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics

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