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Title:When high-powered incentive contracts reduce performance: choking under pressure as a screening device PDF Logo
Authors:Bannier, Christina E.
Feess, Eberhard
Issue Date:2010
Series/Report no.:Working paper series // Frankfurt School of Finance & Management 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.
Subjects:Performance-related pay
screening
choking under pressure
competition
JEL:D86
J31
J33
Document Type:Working Paper
Appears in Collections:Frankfurt School - Working Paper Series, Frankfurt School of Finance and Management

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