You Don't Always Get What You Pay For

Consider a principal-agent relationship in which more eort by the agent raises thelikelihood of success. Does rewarding success, i.e., paying a bonus, increase eort inthis case? I nd that bonuses have not only an incentive but also an income eect.Overall, bonuses paid for success may well reduce eort and hence the probabilityof success. I also identify conditions under which the income eect dominates theincentive eect, and single out the hazard-rate of eort as a crucial determinant ofthis trade-o....