Implicit vs. explicit incentives: Theory and a case study

Empirical studies increasingly question whether standard principal-agent theory applies. We characterize the optimal implicit contract assuming a liquidity constrained agent. Bonus pay decreases while the salary promise and productivity increase with longer expected contract duration. We test our model using personnel data of an insurance company: accounting for the trade-off between salary and performance pay, we confirm that the former (latter) is positively (negatively) correlated with productivity. Longer expected contract duration impacts all three key variables -- i. e. performance pay, salary promise, and productivity -- as predicted by our theoretic model.