Firms often use both objective/verifiable and subjective/non-verifiable performance measures to provide employees with effort incentives. We study a principal/two-agent model in which an objective team-based performance measure and subjective individual performance measures are available for contracting. A problem with tying rewards to subjective measures is that the principal may have incentives to understate the realization of those measures in order to reduce compensation. We compare two mechanisms for overcoming this credibility problem: bonus pools and reputation. While reputation is fostered by repeated interactions (a low discount rate), repeated interactions create opportunities for agent-agent collusion under bonus pools. These opportunities for collusion can be exacerbated by the team performance measure, to the point that it can be optimal to make the size of the bonus pool independent of the realization of the team measure. In general, strong task interdependencies — strategic complementarity or a strategic substitutability of the objective team measure in the agents' actions — improve the effectiveness of reputation-based contracting and reduce the effectiveness of bonus pool arrangements.
Baldenius, Tim, Jonathan Glover, and H. Xue. "Relational Contracts with and between Agents." Journal of Accounting & Economics 61, no. 2-3 (2016): 369-390.
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