Does Bonus Versus Penalty Contract Matter When Workers Can Choose Their Contract?

Abstract

Prior research finds that workers prefer bonus contracts, but provide more effort when assigned to penalty contracts. We extend this research by examining an endogenous labor market where employers offer contracts and workers choose a contract and effort level. We also vary whether employers have discretion over contract offers to isolate how employers’ intentions influence the effect of workers having a choice. When employers did not intentionally offer a contract, worker choice did not affect effort, but as in prior studies, effort was higher under the penalty contract. However, in our fully endogenous market that is most like the natural environment, we find that workers provide more effort when they can choose their contract, and that after controlling for worker choice, bonus and penalty contracts do not affect effort differently. Thus, employers may want to provide workers a choice of contracts to achieve higher worker effort at an equivalent cost.