Abstract
Non-monotone incentive structures, which — according to theory — are able to induce optimal behavior, are often regarded as empirically less relevant for labor relationships. We compare the performance of a theoretically optimal non-monotone contract with a monotone one under controlled laboratory conditions. Implementing some features relevant to real-world employment relationships, our paper demonstrates that, in fact, the frequency of income-maximizing decisions made by agents is higher under the monotone contract. Although this observed behavior does not change the superiority of the non-monotone contract for principals, they do not choose this contract type in a significant way. This is what we call the monotonicity puzzle. Detailed investigations of decisions provide a clue for solving the puzzle and a possible explanation for the popularity of monotone contracts.
Article PDF
Similar content being viewed by others
Avoid common mistakes on your manuscript.
References
Abeler, Johannes, Steffen Altmann, Sebastian Kube, and Matthias Wibral (2006): Reciprocity and Payment Schemes: When Equality is Unfair, Working Paper, SSRN, http://papers.ssrn.com/sol3/papers.cfm?abstract_id=955819 (Access date: 2010-03-29).
Anderhub, Vital, Simon Gächter, and Manfred Königstein (2002): Efficient Contracting and Fair Play in a Simple Principal-Agent Experiment, Experimental Economics, 5 (1): 5–27.
Arrow, Kenneth Joseph and Frank H. Hahn (1980): General Competitive Analysis, 5th ed., North-Holland: Amsterdam.
Bailey, Charles D., Lawrence D. Brown, and Anthony F. Cocco (1998): The Effects of Monetary Incentives on Worker Learning and Performance in an Assembly Task, The Journal of Management Accounting Research, 10: 119–131.
Baker, George P., Michael C. Jensen, and Kevin J. Murphy (1988): Compensation and Incentives: Practice vs. Theory, The Journal of Finance, 43 (3): 593–616.
Balsam, Steven (2002): An Introduction to Executive Compen sation, Academic Press: San Diego.
Barney, Jay B. and Mark H. Hansen (1994): Trustworthiness as a Source of Competitive Advantage, Strategic Management Journal, 15 (Special Issue: Computative Organizational Behaviors): 175–190.
Bartolome, Charles A. M. de (1995): Which Tax Rate Do People Use: Average or Marginal?, Journal of Public Economics, 56 (1): 79–96.
Bolton, Gary E. and Axel Ockenfels (2000): ERC: A Theory of Equity, Reciprocity, and Competition, The American Economic Review, 90 (1): 166–193.
Bonner, Sarah E., Reid Hastie, Geoffrey B. Sprinkle, and S. Mark Young (2000): A Review of the Effects of Financial Incentives on Performance in Laboratory Tasks: Implications for Management Accounting,Journal of Management Accounting Research, 12 (1): 19–64.
Charness, Gary, Guillaume R. Frechette, and John H. Kagel (2004): How Robust is Laboratory Gift Exchange?, Experimental Economics, 7 (2): 189–205.
Charness, Gary and Matthew Rabin (2002): Understanding Social Preferences with Simple Tests, The Quarterly Journal of Economics, 117 (3): 817–869.
Christensen, Peter Ove and Gerald A. Feltham (2005): Economics of Accounting: Performance Evaluation, Springer: Heidelberg.
DeGroot, Morris H. (1970): Optimal Statistical Decisions, McGraw-Hill: New York.
Dutta, Sunil and Stefan Reichelstein (2003): Leading Indicator Variables, Performance Measurement, and Long-Term Versus Short-Term Contracts, Journal of Accounting Research, 41 (5): 837–866.
Falk, Armin and Urs Fischbacher (2006): A Theory of Reciprocity, Games and Economic Behavior, 54 (2): 293–315.
Falk, Armin and Simon Gächter (2002): Reputation and Reciprocity: Consequences for the Labour Relation, The Scandinavian Journal of Economics, 104 (1): 1–26.
Fehr, Ernst, Simon Gächter, and Georg Kirchsteiger (1997): Reciprocity as a Contract Enforcement Device: Experimental Evidence, Econometrica, 65 (4): 833–860.
Fehr, Ernst, Georg Kirchsteiger, and Arno Riedl (1993): Does Fairness Prevent Market Clearing? An Experimental Investigation, The Quarterly Journal of Economics, 108 (2): 437–459.
Fehr, Ernst, Georg Kirchsteiger, and Arno Riedl (1998): Gift Exchange and Reciprocity in Competitive Experimental Markets, European Economic Review, 42 (1): 1–34.
Fehr, Ernst, Alexander Klein, and Klaus M. Schmidt (2004): Contracts, Fairness, and Incentives, CESifo Working Paper Series No. 1215, SSRN, http://www.papers.ssrn.com/sol3/papers.cfm/?abstract_id=549224 (Access date: 2010-03-29).
Fehr, Ernst and Klaus M. Schmidt (1999): A Theory of Fairness, Competition, and Cooperation, The Quarterly Journal of Economics, 114 (3): 817–868.
Fehr, Ernst and Klaus M. Schmidt (2001): Theories of Fairness and Reciprocity: Evidence and Economic Applications, Working Paper, Department of Economics: University of Zurich.
Fehr, Ernst and Klaus M. Schmidt (2004): Fairness and Incentives in a Multi-Task Principal-Agent-Model, The Scandinavian Journal of Economics, 106 (3): 453–474.
Feltham, Gerald A. and Jim Xie (1994): Performance Mea sure Congruity and Diversity in Multi-Task Principal/Agent Relations, The Accounting Review, 69 (3): 429–453.
Feltham, Gerald A., Christian Hofmann, and Thomas Hemmer (2007): Limited Commitment in Multiagent Contracting, Contemporary Accounting Research, 24 (2): 345–375.
Fischbacher, Urs (2007): z-Tree: Zurich Toolbox for Ready-Made Economic Experiments, Experimental Economics, 10 (2): 171–178.
Gächter, Simon and Christian Thöni (2009): Social Comparison and Performance: Experimental Evidence on the Fair Wage-Effort Hypothesis, Working Paper, Department of Economics: University of St. Gallen.
Gneezy, Uri (2002): Does High Wages Lead to High Profits? An Experimental Study of Reciprocity Using Real Effort, Working Paper, The University of Chicago.
Greiner, Ben (2004): The Online Recruitment System ORSEE 2.0: A Guide for the Organization of Experiments in Economics, Working Paper, Department of Economics: University of Cologne.
Grossman, Sanford J. and Oliver D. Hart (1983): An Analysis of the Principal-Agent Problem, Econometrica, 51 (1): 7–45.
Güth, Werner, Wolfgang Klose, Manfred Königstein, and Joachim Schwalbach (1998): An Experimental Study of a Dynamic Principal-Agent Relationship, Managerial and Decision Economics, 19 (4–5): 327–341.
Hart, Oliver and Bengt Holmström (1987): The Theory of Con tracts, in: Truman Fassett Bewley (ed.): Advances in Economic Theory: Fifth World Congress, Cambridge University Press: Cambridge, 71–155.
Holmström, Bengt and Paul Milgrom (1987): Aggregation and Linearity in the Provision of Intertemporal Incentives, Econometrica, 55 (2): 303–328.
Huck, Steffen, Andrew J. Seltzer, and Brian Wallace (2004): Deferred Compensation and Gift Exchange: An Experimental Investigation into Multi-Period Labor Markets, Working Paper, SSRN, http://papers.ssrn.com/sol3/papers.cfm?abstract_id=564572 (Access date: 2010-03-30).
Indjejikian, Raffi and Dhananjay Nanda (1999): Dynamic In centives and Responsibility Accounting, Journal of Accounting and Economics, 27 (2): 177–201.
Jenkins, G. Douglas. Jr., Nina Gupta, Atul Mitra, and Jason D. Shaw (1998): Are Financial Incentives Related to Performance? A Meta-Analytic Review of Empirical Research, Journal of Applied Psychology, 83 (5): 777–787.
Keser, Claudia and Marc Willinger (2000): Principals’ Principles When Agents’ Action Are Hidden, International Journal of Industrial Organization, 18 (1): 163–185.
Lazear, Edward P. (2000): Performance Pay and Productivity, The American Economic Review, 90 (5): 1346–1361.
Leonard, Jonathan S. (1990): Executive Pay and Firm Performance, Industrial and Labor Relations Review, 43 (3, Special Issue): 1–29.
Levine, David K. (1998): Modelling Altruism and Spitefulness in Experiments, Review of Economic Dynamics, 1(3): 593–622.
Lukas, Christian (2007a): Get More for Less? Experimental Evidence on Repeated Decision Making under Non-monotone Incentives, Zeitschrift für Betriebswirtschaft, 77 (4): 351–378.
Lukas, Christian (2007b): Managerial Expertise, Learning Potential, and Dynamic Incentives: Get More for Less?, Managerial and Decision Economics, 28 (3): 195–211.
Nachman, David C. and Tom H. Noe (1995): Operating Efficiency and Output Insensitive Employment Contracts for Capital Management, Economic Theory, 5 (2): 315–335.
Nalbantian, Haig R. and Andrew Schotter (1997): Productivity under Group Incentives: An Experimental Study, The American Economic Review, 87 (3): 314–341.
Nowak, Martin and Karl Sigmund (1993): A Strategy of Win-Stay, Lose-Shift that Outperforms Tit-For-Tat in the Prisoner’s Dilemma Game, Nature, 364: 56–58.
Prendergast, Canice (2002): The Tenous Trade-off between Risk and Incentives, Journal of Political Economy, 110 (5): 1071–1102.
Rabin, Matthew (1993): Incorporating Fairness into Game Theory and Economics, The American Economic Review, 83 (5): 1281–1302.
Rabin, Matthew (1998): Psychology and Economics, Journal of Economic Literature, 36 (1): 11–46.
Roth, Alvin E. and Michael W. K. Malouf (1979): Game-Theoretic Models and the Role of Information in Bargaining, Psychological Review, 86 (6): 574–594.
Sabac, Florin (2007): Dynamic Agency with Renegotiation and Managerial Tenure, Management Science, 53 (5): 849–864.
Bull, Clive, Andrew Schotter, and Keith Weigelt (1987): Tournaments and Piece Rates: An Experimental Study, Journal of Political Economy, 95 (1): 1–33.
Selten, Reinhard, Abdolkarim Sadrieh, and Klaus Abbink (1999): Money Does Not Induce Risk Neutral Behavior, but Binary Lotteries Do even Worse, Theory and Decision, 46 (3): 213–252.
Sprinkle, Geoffrey B. (2000): The Effect of Incentive Contracts on Learning and Performance, The Accounting Review, 75 (3): 299–326.
Van der Heijden, Eline C. M., Jan H. M. Nelissen, Jan J. M. Potters, and Harrie A. A. Verbon (2001): Simple and Complex Gift Exchange in the Laboratory, Economic Inquiry, 39 (2): 280–297.
Author information
Authors and Affiliations
Corresponding author
Rights and permissions
Open Access This article is distributed under the terms of the Creative Commons Attribution 4.0 International License (https://creativecommons.org/licenses/by/4.0), which permits use, duplication, adaptation, distribution, and reproduction in any medium or format, as long as you give appropriate credit to the original author(s) and the source, provide a link to the Creative Commons license, and indicate if changes were made.
About this article
Cite this article
Brosig, J., Lukas, C. & Riechmann, T. The Monotonicity Puzzle: An Experimental Investigation of Incentive Structures. Bus Res 3, 8–35 (2010). https://doi.org/10.1007/BF03342713
Received:
Accepted:
Published:
Issue Date:
DOI: https://doi.org/10.1007/BF03342713