Bonuses and Penalties in Incentive Contracts

Topics:
Incentives and Compensation
Tags:
Contract,
Incentive,
Sales,
Sales Force Management,
University Of Toronto
Source:
University of Toronto

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Overview: With incentive contracts, the standard wisdom is that bonuses and penalties are perfect substitutes, so that contracts should contain one but not the other. In practice, however, one observes contracts that include, and simultaneously implement, both. This paper provides a setting in which optimal incentive contracts contain both bonus and penalty elements. The paper shows that bonuses and penalties arise as an optimal response to an environment in which; there are significant up-front selling costs that are re-coupled by on-going sales; contracts both between the firm and its customers and the firm and its selling agents are incomplete, and the agent has limited access to external capital markets.

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Format: PDF | Size: 219KB | Date: Aug 2002 | Pages: 25

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