Pushing for Compliance: Pay-for-Performance and Managerial Misbehavior

Résumé

Repeatedly, bonuses and variable compensation of managers have been criticized as encouraging non-compliance and thereby ultimately harming a firm’s interest. Yet, this reasoning does not explain why companies found it optimal to offer a given contract in the first place. In particular, incentives in industries where managerial misbehavior is an issue don’t seem to be any lower than in other sectors. We show that large bonuses may in fact prevent agents from ”gaming” incentive schemes and are insofar an optimal response to the threat of non-compliance. This finding has strong policy implications and sheds a new light on the recent proposals to regulate bonuses in the banking industry.