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Performance Standards and Incentive Pay in Agency Contracts
Author(s) -
Sherstyuk Katerina
Publication year - 2000
Publication title -
scandinavian journal of economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.725
H-Index - 64
eISSN - 1467-9442
pISSN - 0347-0520
DOI - 10.1111/1467-9442.00223
Subject(s) - principal (computer security) , punishment (psychology) , incentive , economics , principal–agent problem , microeconomics , agency (philosophy) , moral hazard , limited liability , profit (economics) , liability , profit sharing , actuarial science , business , finance , computer science , computer security , corporate governance , psychology , social psychology , philosophy , epistemology
When the presence of limited liability restricts a principal from imposing monetary fines on an agent in case of poor performance, the principal might use other kinds of punishment threats to deter the agent from shirking. We show that under the optimal contract in this case, the principal sets a performance standard and punishes the agent if the standard is not met, but rewards the agent on a profit‐sharing basis if the standard is significantly exceeded. The optimal choice of performance standards for such contracts is discussed. It is shown that punishment threats, although inefficient, often help the principal to discipline the agent. JEL classification : D 82