Working paper/research report

Publication year: 2010

URL: https://hdl.handle.net/10419/30169

Title of series: Frankfurt School - Working Paper Series

Number in series: 135

Abstract: 

Empirical and experimental papers find that high-powered incentives may reduce performance rather than improve it; a phenomenon referred to as choking under pressure. We show that competition for high ability workers nevertheless leads firms to offer high bonus payments, thereby deliberately accepting pressure-induced performance reductions. Bonus payments allow for a separating equilibrium in which only high ability workers choose high-powered incentive contracts. Low ability workers receive fixed payments and produce their maximum output which, however, is still below the reduced output of high ability workers. Bonus payments lead to a social loss which is increasing in the degree of competition. Our paper helps to explain why steep incentive schemes are persistent in highly-competitive industries such as investment banking, and why the observed performance sensitivity of CEO compensation is largely heterogeneous.

Harvard Citation style: Bannier, C. and Feess, E. (2010) When high-powered incentive contracts reduce performance: Choking under pressure as a screening device. (Frankfurt School - Working Paper Series, 135). Frankfurt am Main: Frankfurt School of Finance and Management. https://hdl.handle.net/10419/30169

APA Citation style: Bannier, C., & Feess, E. (2010). When high-powered incentive contracts reduce performance: Choking under pressure as a screening device. (Frankfurt School - Working Paper Series, 135). Frankfurt School of Finance and Management. https://hdl.handle.net/10419/30169