Performance standards and optimal incentives

Óscar Gutiérrez Arnaiz, Vicente Salas-Fumás

    Research output: Contribution to journalArticleResearchpeer-review

    5 Citations (Scopus)

    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. © 2007 Elsevier B.V. All rights reserved.
    Original languageEnglish
    Pages (from-to)139-152
    JournalJournal of Accounting and Economics
    Volume45
    DOIs
    Publication statusPublished - 1 Mar 2008

    Keywords

    • Earnings
    • Performance standards
    • Piecewise linear contract
    • Semi-heavy tails
    • Variance-Gamma process.

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