Linear contracts as incentives: A puzzle

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    This paper reexamines the linear schedule of compensation as a tool for providing incentives to managers when contractible output is a function of costly effort and a random shock. Two puzzling situations compatible with linear schemes of compensation are presented. First, if the model parameters are such that the optimal participation on output is below 50%, the variable compensation turns out to have a negative effect on manager's utility. Second, if it is below 25%, linear incentives allow situations in which larger utilities are reached by means of smaller rewards. © Springer-Verlag 2007.
    Original languageEnglish
    Pages (from-to)153-158
    JournalSpanish Economic Review
    Publication statusPublished - 1 Jun 2007


    • Certainty equivalent
    • Linear schedules
    • Moral hazard


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