Goal Setting in the Principal-Agent Model: Weak Incentives for Strong Performance
GATE WP 1628 – September 2016
36 Pages Posted: 12 Sep 2016
Date Written: September 12, 2016
We study a principal-agent framework in which principals can assign wage-irrelevant goals to agents. We find evidence that, when given the possibility to set wage-irrelevant goals, principals select incentive contracts for which pay is less responsive to agents’ performance. We show that average performance of agents is higher in the presence of goal setting than in its absence despite weaker incentives. We develop a principal-agent model with reference-dependent utility that illustrates how labor contracts combining weak monetary incentives and wage-irrelevant goals can be optimal. It follows that recognizing the pervasive use of non-monetary incentives in the workplace may help account for previous empirical findings suggesting that firms rely on unexpectedly weak monetary incentives.
Keywords: Principal-agent models, incentive theory, non-monetary incentives, goal setting, reference-dependent utility, laboratory experiments.
JEL Classification: C92, D23, M54
Suggested Citation: Suggested Citation