Incentives and supervision in hierarchies

This paper describes a simple, and therefore limited, model for incentives design under imperfect hierarchical supervision, in order to explain certain empirical evidence on the relative importance of bonuses and salaries for the compensation of managers. Some theoretical implications are also derived from the model: first we find that improvements in the activity of supervision do not always imply higher salaries and less incentives, as is implicitly recognized in certain agency models; secondly, the introduction of incentives in a hierarchy which is performing imperfect supervision may not be sufficient to remove the limits to the firm's size which is attributed to this imperfection. © 1993.