Pay - But Don't Pay Too Much : An Experimental Study on the Impact of Incentives

Most Principal-Agent models predict that increasing incentives result in higher performance. This paper examines whether this result is valid under real-effort conditions. Exposing the participants to varying strengths of incentives we find an inversely U-shaped relationship between effort levels and incentive intensity, which not only contrasts predictions of standard theory but also observations in previous real effort experiments. We provide a new theoretical explanation for the results within a principal agent model with loss averse agents