A common means of incorporating non-verifiable performance measures in compensation contracts is via bonus pools. We study a principal–multi-agent relational contracting model in which the optimal contract resembles a bonus pool. It specifies a minimum joint bonus floor the principal is required to pay out to the agents and gives the principal discretion to use non-verifiable performance measures to both increase the size of the pool and to allocate the pool to the agents. The joint bonus floor is useful because of its role in motivating the agents to mutually monitor each other (team incentives). In an extension section, we introduce a verifiable team performance measure. The broader message that emerges is that "paying for poor performance" — either verifiable team performance or non-verifiable individual performance — can be optimal in a relational (self-enforcing) contracting setting because it creates the trust needed for the principal to tailor other promised payments to motivate mutual monitoring.
Glover, Jonathan, and Hao Xue. "Team Incentives and Bonus Floor in Relational Contracts." Columbia Business School, 2018.
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