Bonus schemes and trading activity

• Published in: Journal of corporate finance (Amsterdam, Netherlands) Netherlands), 2014-12, Vol.29, p.369-389
• Main Authors: Pikulina, Elena, Renneboog, Luc, Ter Horst, Jenke, Tobler, Philippe N.
• Format: Article
• Language: English
• Subjects: Behavior; Bonus; Bonuses; Compensation; Earnings; Information management; Investment decisions; Market timing; Payoffs; Profits; Rates of return; Securities trading; Studies; Trading Behavior
• ISSN: 0929-1199; 1872-6313
• DOI: 10.1016/j.jcorpfin.2014.09.010

Little is known about how different bonus schemes affect traders' propensity to trade and which bonus schemes improve traders' performance. We study the effects of linear versus threshold bonus schemes on traders' behavior. Traders buy and sell shares in an experimental stock market on the basis of fundamental and technical information (past share price evolution, realized earnings, analysts' earnings forecasts, and evolution of the market index). We find that linear and threshold bonus schemes have different effects on trading behavior: traders make more transactions but of a smaller size under the threshold than under the linear bonus scheme. Furthermore, transaction frequency significantly decreases when bonus thresholds are reached but only after building in a safety margin. Under the threshold scheme, the traders' performance is lower (even when there are no transaction costs) than under the linear bonus scheme as a consequence of poorer market timing. This is especially the case when earning money by trading is relatively difficult (i.e., under low profitability conditions). Nevertheless, under low profitability conditions, traders seem to collect more information about the relationships between share price and market returns, earnings, and earnings forecasts, put more effort into understanding those relationships, and thus eventually learn to perform better. •Equity traders trade more frequently under a threshold than under a linear bonus scheme.•Equity traders make smaller trades under a threshold than under a linear bonus scheme.•Trading intensity decreases when bonus thresholds are reached.•Under a threshold scheme, traders' performance is lower due to poorer market timing.•Under low profitability conditions, traders collect more information and eventually perform better.