Consider a principal-agent relationship in which more effort by the agent raises the likelihood of success. Does rewarding success, i.e., paying a bonus, increase effort in this case? I find that bonuses have not only an incentive but also an income effect. Overall, bonuses paid for success may...

We reexamine the issue of executive compensation within a general equilibrium production context. Intertemporal optimality places strong restrictions on the form of a representative manager's compensation contract, restrictions that appear to be incompatible with the fact that the bulk of many...