On the Relative Performance of Linear vs. Piecewise-Linear-Threshold Intertemporal Incentives

This paper employs numerical simulations to compare the relative performance of linear contracts with piecewise-linear-threshold contracts in the case where the agent chooses actions over time. These contracts are restricted to be functions of the ending value of aggregate output. We find strong evi...

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Bibliographic Details
Published in:Management science 2009-10, Vol.55 (10), p.1743-1752
Main Authors: Chen, Joseph Y, Miller, Bruce L
Format: Article
Language:English
Subjects:
Aggregates
Applied sciences
Comparative analysis
Computational methods
Contract incentives
Contracts
Dynamic programming
Exact sciences and technology
Executive compensation
Expected utility
Financial incentives
Incentives
intertemporal incentives
Investment analysis
linear contracts
Management science
Mathematical independent variables
Mathematical programming
Modeling
Objective functions
Operational research and scientific management
Operational research. Management science
Productivity
Programming
Risk aversion
Sales management
salesforce compensation
Salespeople
Simulation
Studies
Utility functions
Wage incentives
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Summary:This paper employs numerical simulations to compare the relative performance of linear contracts with piecewise-linear-threshold contracts in the case where the agent chooses actions over time. These contracts are restricted to be functions of the ending value of aggregate output. We find strong evidence that only linear contracts need be considered in comparison with piecewise-linear-threshold contracts in the situation where cumulative output is only updated periodically and the agent's utility function is exponential. This finding holds even when there are only two periods and hence one change of action by the agent. However, we find that the best piecewise-linear-threshold contract is significantly superior to the best linear contract when the agent has a power utility function. These numerical simulations also call into question the use of a cap when the agent's compensation is based on the ending value of aggregate output and the agent's effort takes place over time.
ISSN:0025-1909
1526-5501
DOI:10.1287/mnsc.1090.1048