Contract Preference and Effort Choice under Bonus, Penalty, and Hybrid Incentive Contracts

We examine the effects of an incentive contract with both penalty and bonus components (a hybrid contract) on individuals’ contract preferences, contract affect (perceived fairness and expected disappointment), and effort level. Our work follows results that indicate that while individuals prefer bonus contracts (because they perceive them to be more fair) they exert more effort under penalty contracts (due to their desire to avoid the penalty). Specially, we examine whether there is a realistic hybrid contract design that agents will not only prefer over the penalty contract but under which they will exert more effort. Our participants prefer bonus to penalty contracts and perceive bonus contracts to be most fair, suggesting that they are not fundamentally different from participants in other contract framing studies. Our main result is that our participants do not differentiate between the hybrid contract and the penalty contract on any dimensions. This suggests that, at least for a hybrid contract with a penalty for low performance and a bonus for high performance on a single outcome measure, principals cannot combine the benefits of bonus and penalty frames into a hybrid contract.