Inducing good behavior: Bonuses versus fines in inspection games

We examine the effectiveness of bonuses and fines in an inspection game where an employer can learn the effort of a worker through costly inspection. Standard game theoretic analysis predicts that fines discourage shirking, whereas bonuses encourage shirking. In contrast, ownpayoff effects suggest that both fines and bonuses discourage shirking. In an experiment we find that fines are more effective than bonuses in reducing shirking. However, we do not find that bonuses encourage shirking. Behavioral theories based on Impulse Balance Equilibrium or Quantal Response Equilibrium provide a good account of deviations from Nash equilibrium predictions.