Contracting with Fair Performance Evaluation as Reference Point

Abstract

I examine robust incentive provision in a dynamic agency model where the agent disagrees with the principal on how he should be evaluated and paid. I use reference points to capture the incentive payment that the agent thinks he deserves and let him inict a disagreement cost on the principal whenever the incentive payment based on the actual output falls short of its counterpart based on the reference point. Results show that many seemingly rigid personnel policies such as eciency wage contract and seniority-based promotion are indeed robust tools for achieving incentive provision and disagreement management simultaneously when the employment relationship is reasonably long.