Affiliation:
1. Quinlan School of Business , Loyola University of Chicago , 16 E Pearson St , Chicago , IL 60611 , USA
Abstract
Abstract
To punish an agent, the principal often incurs costs. I study a principal’s least costly reward and punishment scheme for an agent whose effort the principal cannot observe. I find the principal’s cost is sometimes minimized by using both costly rewards and costly punishments because (1) the agent has an outside option, or (2) a principal without commitment ability repeatedly interacts with the agent. I also find that when an agent’s effort is better at increasing the probability of a good outcome for the principal, the agent’s payoff may decrease, because the principal replaces rewards with punishments.
Subject
General Economics, Econometrics and Finance