Incentive Contracts Research Articles

The Coefficient of Cooperation and CEO Incentive Contracts

It has become increasingly common to reward CEOs based on a firm’s performance relative to that of competitors. Although such incentive contracts can encourage greater CEO effort, there also is concern that they may reduce competition. A duopoly model is developed in which the owner of each firm chooses a relative incentive contract for its CEO that maximizes profit and each CEO makes output market decisions to maximize CEO income. Two important results emerge from the analysis that are not found in the literature. First, the model shows how an incentive contract is directly linked to Cyert and DeGroot’s [[1973] An analysis of cooperation and learning in a duopoly context, Am. Econ. Rev. 63(1), 24–37] “coefficient of cooperation”. The model endogenizes the degree of firm cooperation and clearly reveals how incentive contracts affect competition. Second, the model demonstrates that the optimal incentive contract depends on whether choice variables are strategic substitutes or strategic complements. Thus, the analysis applies to all choice variables, not just output and price as found in previous studies.

Incentive contract for high-quality recycling of construction waste: Considering fairness concerns and information asymmetry

Incentive contract for high-quality recycling of construction waste: Considering fairness concerns and information asymmetry

Incentive Contract, Equity Pooling, and Optimal Securitization Design

ABSTRACTThis paper examines the optimal security design and financing structure for investment funds, considering investors with heterogeneous risk preferences. The private equity (PE) fund serves as an information intermediary that plays a crucial role in aligning incentives and facilitating financing activities. To address the potential misalignment between incentive structures and financing requirements, we develop an integrated framework that incorporates both internal moral hazard and external financing decisions. Our analysis demonstrates that optimal equity incentives effectively align the interests of fund manager and PE fund, thereby enhancing fund performance. The results indicate that the optimal financing mechanism comprises a “waterfall” structure consisting of equity, senior bonds, and junior bonds. Furthermore, we find that pooling equity and issuing asset‐backed securities substantially reduce financing costs, although these costs increase with the size of the financing gap. The dual information asymmetry framework offers novel insights into structured financing and corporate growth strategies.

Multitasking and leadership in optimal incentive contracts

We study multitasking problems where an agent engages in both a contractible and a non-contractible task, which are substitutes. The agent has private information on the value of the non-contractible task, and there are followers (e.g., another agent, a third party, or a principal) who also contribute to this task. The agent’s effort can serve as a signal of the value as in the literature on leading-by-example (Hermalin, 1998). We derive the condition in which the principal provides high-powered incentives for the contractible task to mitigate the agent’s excessive signaling.

Incentive contracts with pay gap and pay equity

This paper explores the impact of non-standard work hours on job performance, with a particular focus on the gender pay gap within the principal–agent model. We develop a moral hazard model that introduces a gender-specific dimension, examining the relationship between optimal contracts and performance pay disparities. We explore two distinct scenarios—one featuring different pay and another with equal pay. The situation with different pay enables us to discern the factors contributing to the wage gap between the two workers. Upon examining the scenario where the contract is constrained to equal pay, we identify two noteworthy outcomes within the optimal contract. Firstly, the compensation structure shifts toward dependence on relative performance, departing from the independent performance evaluation observed in scenarios with different pay. Secondly, equal pay decreases the likelihood of having both the glass ceiling and glass cliff phenomena.

The Impact of Heterogeneous Market Sentiments on Corporate Risk-Taking and Governance

This research focuses on how market sentiment affects corporate governance in the Chinese market. The sample covers the years from 2014 to 2023. Market sentiment is estimated using a cross-sectional absolute deviation (CSAD) model, and earnings quality is used as an indicator of the consequences of corporate governance. Both mutual fund shareholding and the number of firm visits by mutual fund analysts are verified as effective corporate governance instruments that work well in a regular market but become ineffective when the market sentiment is high. The reason for this is that managers’ expectations change, and they may believe that disclosing good news during high-sentiment market periods significantly increases the share prices and helps them meet their performance requirements. In a high-sentiment market, an incentive contract encourages managers to take on projects with inappropriate risk or even manipulate earnings. One potential solution is to adopt venture capital firms’ high-water mark and clawback clauses to prevent managers from focusing on short-term goals rather than seeking long-term business sustainability.

A job ladder model of executive compensation

This paper examines the impact of managerial labor market competition on executive incentive contracts. I develop a dynamic contracting model that incorporates moral hazard, search frictions, and poaching offers. The model generates a job ladder along which executives can either use outside offers to renegotiate with the current firm or transition to outside firms. I show that poaching offers generate a new source of incentives, which explains a novel empirical finding whereby larger firms give executives a higher proportion of incentive compensation.

Dynamic Incentive Mechanism of Collaboration in Prefabricated Building Supply Chain Based on Differential Game

Supply chain collaboration is an important guarantee for improving the performance of prefabricated construction projects and exerting its advantages. The aim of this study was to explore the level and effect of supply chain collaboration under a no-cost-sharing contract, a cost-sharing contract, and a centralized decision-making contract. A dynamic incentive model of prefabricated building supply chain collaboration based on the differential game model was proposed. Considering the impact of BIM on collaboration, the BIM application level was also introduced into the incentive model. Through the comparative analysis of model solution results and numerical simulation, it was found that, in the centralized decision-making contract, the optimal collaborative effort and the optimal total revenue of enterprises in the prefabricated building supply chain were the largest; the optimal collaborative effort of enterprise in the prefabricated building supply chain reduced first and then tended to be stable; and the improvement of the BIM application level could promote collaboration in the prefabricated building supply chain. The results of this study are helpful for managers to select and formulate a reasonable collaboration incentive contract in the prefabricated building supply chain.

Activity-based contracting for optimization of the mass distribution of insecticide-treated nets in the Democratic Republic of Congo: pilot implementation in Kwilu province

BackgroundPromoting the use of insecticide-treated mosquito nets (ITNs) is one of the main strategies for reducing malaria-related morbidity. An innovative activity-based contracting (ABC) approach has been implemented in Kwilu Province, Democratic Republic of Congo to optimize ITN mass distribution campaigns, with payments based on contractually defined programmatic outcomes for key campaign activities following independent verification of results.MethodsThis internal evaluation was carried out using a mixed methods approach combining qualitative and quantitative document and content analysis from a series of three workshops: validation workshops for campaign results at provincial level for the 2021 and 2022 campaigns; internal evaluation workshop for the Kwilu campaign as part of the ABC approach organized by “Santé pour tous en milieu rural” (SANRU) with its sub-contractors; and national campaign evaluation workshop organized by the National Malaria Control Program.ResultsThe pilot campaign with the ABC approach in Kwilu has demonstrated better results than campaigns conducted using the standard, non-ABC, approach: better household coverage (99.9% vs. 97.3%) and improved compliance with ITN allocation to households based on the household size (98. 9% vs. 84.7%); lower loss of ITNs (0.3% vs. 0.5%) with immediate penalties for lost ITNs in the province under the ABC approach; shorter campaign lead times (14 vs. 28 weeks from the start of training to the launch of distribution). This last point is crucial, as it is likely to generate efficiencies and contribute to ensuring timely ITN replacement campaigns.ConclusionThe challenges encountered and the lessons learned in the implementation of the pilot ABC approach in Kwilu could guide future distribution campaigns in the DRC and other African countries that would like to engage in distribution campaigns based on performance-based incentive contracts.

Financial hedging incentive contracts in global supply chains: A distributionally robust approach

AbstractThis paper developed a global supply chain with a supplier and a retailer in different countries. When exchange rate and demand risks are concentrated in retailer, a distributionally robust approach is used to formulate an optimized robust ordering strategy. Furthermore, the effect of financial hedging incentive contracts on the robust decisions and the profits of the global supply chain is explored. Our findings show that the correlation between exchange rate and demand does not affect the robust decisions of retailer. The effectiveness of financial hedging incentive contracts depends on the trade‐off between transaction costs of financial hedging and the degree of supplier incentives and the growth rate of order quantity.

A Study on the Design of Incentive Contracts for Platform Economy Regulation Based on Dual Principal–Agents

A system of incentives can be established to encourage several parties to unite as a community of interest and become jointly committed to the platform economic governance. The platform economy involves progressively more complex subjects of interest and relationships, which are not the typical principal–agent one-time cooperative relationship. This study investigates the problem of regulatory incentives in the platform economy, specifically focusing on the relationship between the government, platform enterprises, and merchants. It analyzes this issue under conditions of asymmetric information by constructing and solving a dual principal–agent model. The findings indicate the following: (1) the government’s incentives and regulatory mechanisms can be considered as interchangeable to some extent, with decisions made by evaluating their respective costs; (2) the government’s optimal incentives and regulations ultimately shape the self-regulatory behavior of merchants through platform enterprises; and (3) the optimal level of incentives for both the government and the platform enterprise is influenced by factors such as the ability coefficient, the social transformation coefficient, and the merchants’ reliance on the platform enterprise. Additionally, the optimal effort level of the platform enterprise and the merchants increases with higher levels of the regulatory effort, risk sensitivity coefficient, and ability coefficient. A win–win scenario and a long-term, stable cooperative partnership can be reached by the three parties under the ideal incentive intensity. The study’s conclusions can serve as a theoretical foundation and support for the creation of incentive contracts for platform economy regulation.

Performance comparison and incentive contracts

Workers use publicly observable performance information to evaluate their and their peers' status, thereby feeling superior or inferior. We analyze how such performance comparison affects optimal incentive contracts. In our model, a principal employs agents who may gain or lose utility by comparing their performance signals. We establish the following results. First, the optimal contract of each agent is based only on his own performance signal and muted compared to the setting with no performance comparison. Second, agents' performance comparison has a nontrivial effect on the principal's expected payment. Third, in the labor market where the principal cannot observe agents' sensitivity to performance comparison, she can attract the most desirable agents under some reasonable assumptions. We discuss the practical implications of these results.

An Empirical Study of Contract Governance and Relationship Governance and their Impact on Construction Project Performance

The construction industry holds a pillar position in the national economy, but its efficiency paradox is increasingly prominent. An important finding of this study is that there is no contradictory relationship between contract incentives and contract adaptation in construction projects, that is, contract governance in construction projects can achieve both contract incentives and contract adaptation effects, both of which can promote project performance. This contradicts the opposing relationship between contract incentives and contract adaptation supported by existing research, which suggests that the enhancement of one effect always comes at the cost of the weakening of another effect.

Perks and labor investment efficiency: Evidence from China

This study investigates the effect of perks on future labor investment efficiency. Agency theory suggests that perks motivate managers to distort investments for personal gain. By contrast, incentive contract theory suggests that perks can be a component of incentive contracts, encouraging managers to make investments in the best interest of shareholders. Based on a sample of 12,818 firm–year observations from 2009 to 2017, we find that perks are positively related to future labor investment inefficiencies, consistent with agency theory. An exogenous reduction in executive perks caused by the 2012 anti-corruption campaign decreases labor investment inefficiencies. Further analyses show that the positive effect of perks on overinvestment predominantly occurs when firms have excessive free cash flow, low political visibility, and a less-educated workforce, whereas the positive relationship between perks and underinvestment is more prevalent. Finally, we find that perks and labor investment inefficiencies are detrimental to firm value.

Early warning response to rainstorm: Designing a model with incentive and supervision mechanisms based on the principal-agent theory

Owing to the increasing frequency of rainstorm disasters, strengthening the link between meteorological warning and emergency response that is early warning response has become crucial. However, early warning response usually fail, the underlying reasons behind this phenomenon and their improvement measures need to be urgently explored. This study uses the principal–agent theory to establish an incentive-constraining model based on hierarchical government to explore this problem. Considering the interest game between the superior and local governments, we mainly discuss how to design the optimal incentive mechanism under the condition of information asymmetry to enhance the local government's enthusiasm for providing an early warning response to rainstorm, thereby maximizing the benefits for both parties in the model. Furthermore, based on actual conditions, we use numerical simulation to present the model results more clearly. The results indicate that incentive and supervision mechanisms are mutually substitutable. Strong early warning capability and active public cooperation can improve the local government's enthusiasm for providing an early warning response. Excessive costs lead the local government to adopt a negative attitude toward warning, regardless of supervision is introduced. Only when the local government exhibits strong risk aversion and its investment is affected by numerous random factors, introducing supervision is effective. Meanwhile, too many external factors, excessive or insufficient supervision's intensity also affect the optimization effect of supervision on incentive contract. To maximize the effectiveness of supervision, the superior government should improve the supervision team's capability, and maintain the supervision's intensity within a reasonable range.

The Effect of Narcissism and Contract Frame on Employee Performance in the Presence of an Ex Ante Target

ABSTRACT Incentive contracts containing ex ante targets are prevalent in organizations. Although prior research indicates that contract frame has no significant impact on employee performance when an ex ante target is assigned, we provide a more nuanced view by examining the role of narcissism in this relationship. Results indicate when an ex ante target is assigned, less narcissistic employees perform better than more narcissistic employees regardless of contract frame. In addition, target difficulty plays a role. When narcissism is lower, employees working under a less difficult target perform better than those working under a more difficult target, but there is no effect of contract frame. When narcissism is higher, we find an interaction between contract frame and target difficulty. When the target is less difficult, employees higher in narcissism perform better under the penalty than the bonus contract frame, whereas the opposite is the case when the target is more difficult. Data Availability: Data are available from the authors upon request. JEL Classifications: M41.

Drivers of innovation in infrastructure development projects: A configurational analysis of boundary spanning roles

Innovation can provide new opportunities to improve project efficiency. However, enabling innovation is challenging, especially in public infrastructure development projects. Several impeding factors, such as limited contractual incentives and complexity, are prevalent in contract-based collaborative environments. Literature suggests that boundary spanners play an important role in driving innovation by seizing opportunities. This study aims to identify configurations of boundary spanning roles in typical project situations— varying in contract type and complexity— to facilitate innovation. The empirical data is from 58 projects and analyzed using fuzzy-set Qualitative Comparative Analysis (fsQCA). Results show that depending on the project conditions in terms of contract type and complexity, different combinations of boundary spanning roles can be taken up by project managers or other team members to facilitate innovation. This study highlights that in high-complexity situations, boundary spanning roles play a critical role in maintaining good relationships with collaborators, which is instrumental in developing innovation.

Dynamic incentive mechanisms in mega project-risk management considering the participation of the insurance company

PurposeThe construction of megaprojects often involves substantial risks. While insurance plays an important role as a traditional risk transfer means, owners and insurance companies may still suffer huge losses during the risk management process. Therefore, considering the strong motivation of insurance companies to participate in the on-site risk management of megaprojects, this study aims to propose a collaborative incentive mechanism involving insurance companies, to optimize the risk management effect and reduce the risk of accidents in megaprojects.Design/methodology/approachBased on principal-agent theory, the research develops the static and dynamic incentive models for risk management in megaprojects, involving both the owner and insurance company. The study examines the primary factors influencing incentive efficiency. The results are numerically simulated with a validation case. Finally, the impact of parameter changes on the stakeholders' benefits is analyzed.FindingsThe results indicate that the dynamic incentive model is available to the achievement of a flexible mechanism to ensure the benefits of contractors while protecting the benefits of the owner and insurance company. Adjusting the incentive coefficients for owners and insurance companies within a specified range promotes the growth of benefits for all parties involved. The management cost and economic benefit allocation coefficients have a positive effect on the adjustment range of the incentive coefficient, which helps implement a more flexible dynamic incentive mechanism to motivate contractors to carry out risk management to reduce risk losses.Originality/valueThis study makes up for the absence of important stakeholders in risk management. Different from traditional megaproject risk management, this model uses insurance companies as bridges to break the island effect of risk management among multiple megaprojects. This study contributes to the body of knowledge by designing appropriate dynamic incentive mechanisms in megaproject risk management through insurance company participation, and provides practical implications to both owner and insurance company on incentive contract making, thus achieving better risk governance of megaprojects.

Foundation-controlled firms and CEO compensation

We explore the effects of foundation control on CEO incentive contracts. Unlike other blockholders, foundations do not consume the entirety of their cash flow rights, which attenuates the incentives of the controlling foundations to directly monitor the management. We present a simple model of moral hazard which predicts that foundation-controlled (FC) firms will resort to executive compensation as an alternative disciplining mechanism. Using a sample of listed Swedish family firms over the period of 2001–2014, we find that CEOs in FC firms are awarded more stock options compared to their peers in non-FC firms. The performance sensitivity of their option portfolios is also higher, but we do not find this to be the case for stock grants. Lastly, there is no conclusive evidence of differences in the levels of cash compensation. Our findings support the view that incentive contracts can substitute for large shareholder monitoring.

Incentive contract design for reducing carbon emissions in the supply chain under asymmetric information

AbstractIn light of the volatility of market demand and carbon trading prices, this study examines the effects of two carbon policies—the carbon tax policy and the cap‐and‐trade policy—as well as various information structures on the supply chain's carbon emission reduction incentives. A brand incentivizes the carbon abatement effort of an upstream supplier through a two‐part contract in the form of a fixed salary and a proportional incentive. We discover that, under some circumstances, the brand may benefit more from the unobservability of supply chain information. The brand bundles the risk of uncertainty with the supplier through the proportional incentive. In classical incentive contracts, only the cost is considered and the positive effect of risk conveyance is often ignored. In our study, the brand needs to investigate a trade‐off between the benefit of risk conveyance and the drawback of the incentive cost. On one hand, the proportional incentive characterizes the incentive cost. The brand increases the incentive intensity due to the unobservable effort of the supplier. On the other hand, it also has a risk conveyance effect. Specifically, the proportional incentive decreases with the correlation coefficient under the cap‐and‐trade policy. Additionally, there are situations in which consumer surplus benefits from the observability of supply chain information. However, supply chain information transparency is harmful to consumer surplus as supplier risk aversion increases.