Incentives and Contract Frames

Abstract

Principal-agent problems are pervasive in economic settings. CEOs and shareholders, lawyers and clients, manufacturers and retailers, lenders and borrowers are all examples of settings in which moral hazard problems might arise. Incentive contracts in both individual and team environments have been studied by economists (see Shavell (1979) and Holmstrom (1982, 1979) for seminal theoretical work, and Prendergast (1999) for a survey of empirical literature). Contracts that tie an agent's compensation to performance, such as conditional bonus schemes, have been proposed as a way to align the interests of agents and principals. Experimental literature from economics and social psychology suggests that the way choices are framed can affect decisions as well. Hence, contract frames might influence the effectiveness of incentive schemes. This comment first outlines seminal experimental work on frames and describes a recent study that relates the incentive contract literature with the experimental work on frames. Second, it discusses the experimental design and findings of Brooks, Stremitzer, and Tontrup's (2011) work on individual incentives and contract frames.