Optimal Incentive Contracts Research Articles

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.

Enhancing synergistic performance through implicit incentive contracts: Addressing the “talent dilemma” in the public sector

AbstractBecause of the conflict between the traditional public sector values of egalitarianism and new public management, talent management (TM) in the public sector is more difficult to implement under resource constraints. Equity and efficiency in China's public sector are squeezed out of each other under egalitarianism, resulting in the “ talent dilemma” in which talent works more but does not get more. The “talent dilemma” leads to the fact that it is very attractive for talents to hide their abilities and reduce their efforts in the public sector. In this paper, from the perspective of the “talent dilemma”, we study the contract design problem of the coexistence of heterogeneous talent's adverse selection and moral hazard in the public sector. Specifically, an incentive model combining exclusive and inclusive TM factors under information asymmetry is constructed. The optimal incentive contract is designed to motivate heterogeneous talents to display true information about their abilities and to maintain a maximized level of effort. The results of the study show that the optimal incentive contract can realize the role of information screening and break the “talent dilemma”. These findings provide a theoretical basis for the reform of incentive mechanisms in the public sector.

Analysis of incentive mechanism and contractor behaviours under informatisation construction in megaprojects

PurposeAs the complexity and uncertainty of megaprojects make it difficult for traditional management models to address the difficulties, this paper aims to design a performance incentive contract through IT applications, thereby promoting the formation of an information-based governance mechanism for megaprojects and facilitating the transformation and upgrading of the construction management model of megaprojects to informatisation.Design/methodology/approachThis paper introduced IT applications into the performance assessment and used the proportion of IT applications replacing traditional manual management as a variable. It analysed different replacement ratios to obtain the optimal solution for the change of contractors behaviours and promote the optimal performance incentive for the informatisation in megaprojects.FindingsThe results show that under the condition of the optimal replacement ratio, achieving the optimal state of a mutual win-win situation is possible for the benefit of both sides. The counter-intuitive finding is that the greater the replacement ratio is not, the better, but those other constraints are also taken into account.Originality/valueThis study enriched the research of the performance configuration incentive from a practical perspective. It extended the research framework of IT incentive mechanisms in the governance of megaprojects from a management theory perspective. It clarified the role of IT applications in incentive mechanisms and the design process of optimal incentive contracts under different performance incentive states. The incentives made the contractors work harder to meet the owner's requirements, and it could improve the efficiency of megaprojects, thus better achieving megaproject objectives.

Accounting conservatism and managerial information acquisition

We study the interaction between optimal financial reporting rules and managers' incentives to gather additional information about firm performance. Accounting-based covenants transfer control rights to lenders, allowing them to take corrective actions. After the accounting report is released, the manager can exert effort to uncover whether the report is a false alarm or unduly optimistic. The manager's incentive to gather information stems from optimal incentive contracts and private benefits of control that she loses when the project is liquidated. We derive conditions under which managerial information acquisition renders conservative reporting optimal for shareholders and show that these conditions relax when the manager derives greater private benefits from the project or the cost of information acquisition declines. Our model provides novel explanations for existing empirical findings and offers new predictions with respect to covenant waivers, debt contract renegotiations, and the frequency of corrective actions.

Incentive Mechanism Analysis of Environmental Governance Using Multitask Principal–Agent Model

In view of the principal–agent relationship between local government and pollution enterprise in environmental governance, this paper established a multitask principal–agent model, gave the optimal contract form of local government incentive to enterprises, examined the influencing factors of the optimal incentive contract, and focused on analyzing the influences of institutional factors, enterprise types and enterprise attributes on the optimal incentive contract. The results show that the optimal incentive contract is affected by the influence coefficient of enterprise economic benefits on local government revenue, the environmental index weight in government performance systems, the types of enterprise, the risk preference of enterprise, the variance in economic benefits, the variance in pollution emission reduction, the ability of economic benefits, the direct cost of emission reduction and the economic cost (income) of emission reduction. In order to realize the coordinated development of economy and environment, the establishment and adjustment of optimal incentive contract should be established or adjusted according to the institutional factors, different types of enterprise, and the enterprise characteristics. Local governments should divide enterprises into traditional enterprises and green innovative enterprises in the process of management. The policy formulation of the local government should be based on the characteristics of the system and cooperate with the national strategy. Local governments should actively collect and master the attribute information of the enterprises, including risk preference, profit model, pollution control technology and ability, management experience and level, production mode and green innovation ability. Local governments should combine the types of enterprises, the characteristics of institutions and the attributes of enterprises, and adjust various policies and measures more flexibly.

Optimal incentive contract in continuous time with different behavior relationships between agents

Dynamic contracts with multiple agents is a classical decentralized decision-making problem with asymmetric information, it is usually discussed according to moral hazard and the behavioral relationship between agents. To do so, in this paper, according to behavior relationships between agents, we analyze continuous time optimal contracting in principal multi-agent moral hazard settings. According to stochastic optimal control theory, the optimal contract of the generalized principal-agent dynamic problem is given, the optimal behavior selection and incentive mechanism of agents are analyzed. The result shows that, in the two-agent model, the incentive effect of cooperative relationship is greater than that of competitive relationship; when they are in a cooperative relationship, with the more influential agent receiving higher pay; under multi-agent model, an increase in the number of agents reduces effort and rewards, this indicates that the team size has strict boundaries. The research conclusions can be applied to solve two kinds of principal-agent problems that the principal needs to motivate the agent to compete or cooperate in the actual social production and life.

The impact of blockchain on optimal incentive contracts for online supply chain finance.

In China, supply chain finance is still in infancy. However, it is the problems of information sharing, trust transfer, and risk management that have been making it difficult to meet the financing needs of small- and medium-sized enterprises (SMEs) in supply chain. The emerging blockchain technology, with its unique decentralization, traceability, and other characteristics, has found a digital solution for traditional supply chain finance. Although blockchain has attracted widespread attention and there are more general descriptions of blockchain application areas, there are few researches on the impact mechanisms of blockchain in-depth. Especially in the field of supply chain finance, there is little research on optimal incentive contract in online supply chain finance empowered by blockchain technology. Therefore, this paper explores the influence of blockchain technology maturity on participants, and thus finds the optimal incentive contract in online supply chain empowered by blockchain technology. Because of the mastery of blockchain technology, platforms believe they are well protected against risk and may behave irrationally. Therefore, this paper considers the overconfident behavior of blockchain supply chain finance platform in actual operation, and then applies the principal-agent model and incentive theory to design the incentive mechanism between platforms, banks, and central banks. Finally, numerical analyses show that overconfident behavior and the maturity of blockchain technology have an impact on the optimal decision for the whole supply chain.

Big bath accounting and CEO turnover: the interplay between optimal contracts and career concerns

Following executive turnovers big bath accounting is often observed. We investigate a new manager’s earnings management incentives in his first year in office in a two-period model with career concerns and earnings’ lack of timeliness. We determine the optimal incentive contract and decompose the manager’s equilibrium earnings management into two components: an explicit incentive resulting from the compensation contract and an implicit incentive from career concerns. While career concerns always motivate the manager to shift earnings backwards, the optimal contract induces the manager to either shift earnings forwards or backwards. In particular, we show that with optimal contracts a "negative" big bath may result in equilibrium, i.e., the manager may inflate earnings after a CEO turnover. We demonstrate how the optimal contract and the equilibrium earnings management strategy depend on the earnings’ timeliness, the precision of the initial information about the manager’s ability and the intensity of competition for CEOs. Our results may help to explain why big bath accounting after a CEO turnover is observed in many but not in all cases.

The incentive contract of subject librarians in university library under the non-linear task importance

Abstract Under the information asymmetry, we consider the impact of task importance on the income of university managers, introducing the non-linear income function of university managers. Based on the principal-agent theory, we construct a non-linear incentive optimisation model for subject librarians. We discussed how university managers allocate incentive intensity and how the subject librarians allocate the effort level to achieve the best net expected income for university administrators and subject librarians while satisfying the constraints of participation and incentive compatibility. The results show that the optimal incentive contract for subject librarians is related to task importance, ability level, risk aversion characteristics and the randomness of the external environment in university libraries. The relative incentive intensity increases with the increase of task importance, risk aversion, ability level and randomness of information retrieval tasks, and decreases with the increase of randomness of subject service tasks.

Optimal Incentive Contract in Continuous Time with Different Behavior Relationships between Agents

Optimal Incentive Contract in Continuous Time with Different Behavior Relationships between Agents

Contracts design for serial delivery with connecting time spot: From a perspective of fourth party logistics

For a serial delivery system, the latter 3PL needs to be prepared at the transshipment node in advance to reduce the total delivery time. In this paper, we propose the concept of Connecting Time Spot (CTS) to help 4PL schedule the latter 3PL when to wait at the transshipment node. We study a serial delivery system with a 4PL and two 3PLs, where 4PL designs optimal contracts with two types of CTS (GCTS is derived by system parameter and DCTS is determined by 4PL’s optimization) to induce 3PLs to exert the optimal effort levels. We analyze the effects of CTS on the system profit in the centralized system. For the decentralized system, we particularly investigate the optimal contracts in three penalty modes which are according to the occupancy of the warehouses. The results show that CTS can avoid 3PLs’ idle resources and enhance the system profit for serial delivery both in the centralized system and the decentralized system. Compared with GCTS, DCTS has a better performance in enhancing the system profits. Also, the optimal incentive contracts achieve Pareto improvement for system profits. Interestingly, one 3PL’s delivery penalty mode will not affect the other 3PL’s optimal contracts.

Stock-based pay, liquidity, and the role of market making

We study the role of stock market characteristics on managerial compensation. A risk averse manager exerts an unobservable effort that drives future firm value. The value cannot be used in the incentive contract because it realizes in the distant future and compensating the manager cannot be postponed until then. The stock price emerges endogenously because of trading by informed and uninformed traders in a standard competitive noisy rational expectations equilibrium model. We identify new “skin-in-the-game” and “information-overlap” terms in the weights the optimal incentive contract gives to the stock price and to public information. We derive novel comparative statics, e.g., the manager may receive more stock-based pay when traders' information becomes worse. The contract always uses public information except in the special case when uninformed traders are risk-neutral.

Assignment under task dependent private information

• An agent can exploit his private information only after undertaking an investment approved by the principal. • The post-investment inefficiencies affect the principal’s decision to assign the agent to invest ex ante. • A better distribution of investment returns can lead to the principal assigning less agents to invest. An agent’s private information on his investment return is payoff-relevant only upon investment. This paper studies the contracting and assignment problem of a principal who can assign her agent to invest, which improves the agent’s future productivity but allows the agent to exploit his private information for an information rent, or continuously produce, which prevents post-investment adverse selection but causes stagnation in productivity. With moral hazard in production, the optimal incentive contracts induce efficient production by agents without investment, but the improved productivity of any investment is under-exploited. A better distribution of investment returns can worsen inefficiency, with the principal possibly assigning less agents to invest.

The equilibrium of venture capital incentive contract: Optimization and Q-learning approaches

This paper presents an incentive contract model for allocating the income of venture projects. Venture Capital (VC), as one of the main sources of financing innovative projects, faces challenges like moral hazards, information asymmetry and interest conflicts (three agency problems). In addition to identifying the items that may affect the income of venture projects and the introduction of cost functions, we present an optimal incentive contract model from the perspective of both venture capitalists and entrepreneurs. In this model, a venture capitalist, as an active investor, provides managerial and training assistance to the entrepreneur. The results showed that the higher the initial ability of the entrepreneur, the less money the venture capitalist pays for training. Furthermore, the wealth that the contract parties can obtain if the venture contract is not accepted, is an influential factor in the contract payment function. This model has also been studied with bounded rationality hypothesis and has been implemented using the Q-learning algorithm. In addition, the results obtained from the Q-learning approach, are reasonably convergent with the Nash equilibrium.

Quality incentive contract design in government procurement of public services under dual asymmetric information

In the process of government procurement of public services (GPPS), adverse selection and moral hazard caused by dual asymmetric information can damage public interests and negatively affect the quality of public services. To improve the quality of GPPS, in this study, quality incentive contract models under the condition of dual asymmetric information are designed. These models are based on the optimal incentive contract model in principal–agent theory. The results show that under dual asymmetric information conditions, incentive contracts designed for a continuous type of service capability can identify and stimulate the service abilities of social organizations.

Optimal contract design with a common agency in last-mile logistics

Cooperative package collection is challenging given the lack of contract design to guarantee that the shared last-mile logistics (LML) provider divides the workload among all partners in a fair way, as it may influence the customer’s carrier choice when sending a package. However, the agency’s fairness may be influenced by principals’ individual incentives. To solve this issue, we establish a theoretical model with multiple principals (express companies) and a common agency (LML provider). We find that the optimal ex ante contract among collusive principals is a profit-sharing contract, which ensures that the principals have no motivation to take hidden actions to influence the agency’s workload division. We also provide the optimal incentive contract between the coalition and the agency.

Agency theory meets matching theory

The theory of incentives and matching theory can complement each other. In particular, matching theory can be a tool for analyzing optimal incentive contracts within a general equilibrium framework. We propose several models that study the endogenous payoffs of principals and agents as a function of the characteristics of all the market participants, as well as the joint attributes of the principal–agent pairs that partner in equilibrium. Moreover, considering each principal–agent relationship as part of a market may strongly influence our assessment of how the characteristics of the principal and the agent affect the optimal incentive contract. Finally, we discuss the effect of the existence of moral hazard on the nature of the matching between principals and agents that we may observe at equilibrium, compared to the matching that would happen if incentive concerns were absent.

Tractable Compensation Plan under Asymmetric Information

In an elegant study on salesforce incentive design, Steenburgh and Ahearne (2012) have argued that a multi‐faceted portfolio approach, based on the classification of workers into laggards, core, and star performers, can induce better result from the salesforce, compared to traditional approaches used in companies. In this paper, we construct a portfolio of incentive contracts with a three‐piece “linear–quadratic–linear” structure and study their incentive effects. It is well known that such contracts can extract 100% of the incremental benefits (i.e., optimal) when the performance levels of the agents are exponentially or uniformly distributed, but its effect is still unknown in the more natural case when performance levels are normally distributed. We show that the proposed three‐piece contract can capture more than 95.32% of the incremental benefits, obtained from the optimal incentive contract over fixed salary contract, when the cost functions of efforts are quadratic, and the performance levels are normally distributed. In this case, the more traditional three‐piece linear contract has a corresponding tight lower bound of 82.64%. Interestingly this is the same as the tight lower bound from a two‐piece linear contract, and thus adding more linear pieces to the contract does not help to improve the lower bound when the performance levels follow the normal distributions. This provides a partial theoretical explanation for the superiority of the portfolio approach advocated by Steenburgh and Ahearne (2012).

Optimal Incentive Contract with Asymmetric Cost Information

AbstractAs a prevalent problem for construction projects, contractor cost details are unobserved or unknown to the owner. This paper considers a risk-averse owner (he) who engages a risk-neutral co...

Optimal incentive contract with endogenous monitoring technology

Recent technology advances have enabled firms to flexibly process and analyze sophisticated employee performance data at a reduced and yet significant cost. We develop a theory of optimal incentive contracting where the monitoring technology that governs the above procedure is part of the designer's strategic planning. In otherwise standard principal–agent models with moral hazard, we allow the principal to partition agents' performance data into any finite categories, and to pay for the amount of information the output signal carries. Through analysis of the trade‐off between giving incentives to agents and saving the monitoring cost, we obtain characterizations of optimal monitoring technologies such as information aggregation, strict monotone likelihood ratio property, likelihood ratio–convex performance classification, group evaluation in response to rising monitoring costs, and assessing multiple task performances according to agents' endogenous tendencies to shirk. We examine implications of these results for workforce management and firms' internal organizations.