Scandinavian Working Papers in Economics

Discussion Papers,
Norwegian School of Economics, Department of Business and Management Science

No 2006/22: The rise of individual performance pay

Ola Kvaløy () and Trond E. Olsen ()
Additional contact information
Ola Kvaløy: Norsk hotellhøgskole, Institutt for økonomi og ledelse, University of Stavanger, Postal: University of Stavanger, 4036 Stavanger, Norway
Trond E. Olsen: Dept. of Finance and Management Science, Norwegian School of Economics and Business Administration, Postal: NHH , Department of Finance and Management Science, Helleveien 30, N-5045 Bergen, Norway

Abstract: Why does individual performance pay seem to prevail in human-capital-intensive industries where teamwork is so common? We present a model that aims to explain this. In a repeated game model of relational contracting, we analyze the conditions for implementing peerdependent incentive regimes when agents possess indispensable human capital. We show that the larger the share of values that the agents can hold-up, the lower is the implementable degree of peer-dependent incentives. In a setting with team effects - complementary tasks and peer pressure, respectively - we show that while group-based incentives are optimal if agents are dispensable, it may be costly, and in fact suboptimal, to provide team incentives once the agents become indispensable.

Keywords: Relational contracts; multiagent moral hazard; indispensable human capital

JEL-codes: D23; J33; L14

28 pages, December 11, 2006

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