Discussion Papers, Department of Business and Management Science, Norwegian School of Economics (NHH)
Oddvar M. Kaarbøe
Distorted Performance Measures and Dynamic Incentives
() and Trond E. Olsen
Abstract: Incentive contracts must typically be based on performance
measures that do not exactly match agents' true contribution to principals'
objectives. Such misalignment may impose difficulties for effective
incentive design. We analyze to what extent implicit dynamic incentives
such as career concerns and ratchet effects alleviate or aggravate these
problems. Our analysis demonstrates that the interplay between distorted
performance measures and implicit incentives implies that career and
ratchet effects have real effects, that career and monetary incentives may
be complements, and that stronger ratchet effects or more distortion may
increase optimal monetary incentives.
Keywords: Incentive contracts; Performance measures; (follow links to similar papers)
JEL-Codes: J41; (follow links to similar papers)
20 pages, December 29, 2004
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