Dynamic Nonmonetary Incentives

Authors: Daniel Bird and Alexander Frug

American Economic Journal: Microeconomics, Vol. 11, No 4, 111-150, November, 2019

We study a principal-agent interaction where investments and rewards arrive stochastically over time and are privately observed by the agent. Investments (costly for the agent, beneficial for the principal) can be concealed by the agent. Rewards (beneficial for the agent, costly for the principal) can be forbidden by the principal. We ask how rewards should be used and which investments incentivized. We identify the unique optimal mechanism and analyze the dynamic investment and compensation policies. When all rewards are identical, the unique optimal way to provide incentives is by a "carte blanche" to pursue all rewards arriving in a predetermined time frame.

This paper originally appeared as Barcelona GSE Working Paper 938