Bonus and Penalty Schemes as Equilibrium Incentive Devices, with Applications to Manufacturing Systems

Posted: 26 Oct 1999

See all articles by Debra J. Aron

Debra J. Aron

Navigant Economics; Ankura Consulting Group; Northwestern University

Pau Olivella

Autonomous University of Barcelona - Department of Business Administration; International Health Economics Association (iHEA)

Abstract

This article reconciles the psychological notion of bonuses and penalties as incentive devices with an economic view of incentives. An objective definition of bonus and penalty schemes is presented and shown to correspond to equilibria in a model of moral hazard and probabilistic monitoring. The model implies that middle-management and other nonproduction jobs are appropriate for bonus-type incentive contracts, whereas in either unskilled jobs or aspects of highly skilled jobs that require diligence but no skill, penalty incentive schemes are predicted. We argue that our model illuminates an internal contradiction in the prospect theory of Kahneman and Tversky. We also argue that Japanese manufacturing systems have inherent incentive properties that elicit a high level of diligence from factory workers.

JEL Classification: D81, D82, J53

Suggested Citation

Aron, Debra J. and Aron, Debra J. and Olivella, Pau, Bonus and Penalty Schemes as Equilibrium Incentive Devices, with Applications to Manufacturing Systems. Available at SSRN: https://ssrn.com/abstract=5316

Debra J. Aron (Contact Author)

Ankura Consulting Group ( email )

1200 19th Street
Ste 600
Washington, DC 20036
United States

Navigant Economics ( email )

1603 Orrington Ave
Suite 1500
Evanston, IL 60201
United States
847 424 4110 (Phone)

Northwestern University

Evanston, IL

Pau Olivella

Autonomous University of Barcelona - Department of Business Administration ( email )

Campus Bellaterra Edifici B.
Bellaterra (Barcelona), 08193
Spain
3493-581 2369 (Phone)
3493-581 24 61 (Fax)

International Health Economics Association (iHEA) ( email )

435 East Durham Street
Philadelphia, PA 19119
United States

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