SUBJECTIVE PERFORMANCE MEASURES IN OPTIMAL INCENTIVE CONTRACTS

SUBJECTIVE PERFORMANCE MEASURES IN OPTIMAL INCENTIVE CONTRACTS

Incentive contracts often include important subjective components that mitigate
incentive distortions caused by imperfect objective measures. This paper explores the
combined use of subjective and objective performance measures in (respectively)
implicit and explicit incentive contracts. We show that the presence of sufficiently
effective explicit contracts can render all implicit contracts infeasible, even those that
would otherwise yield the first-best. We also show, however, that in some
circumstances objective and subjective measures are complements: neither an explicit
nor an implicit contract alone yields positive profit, but an appropriate combination of
the two does. Finally, we consider subjective weights on objective measures.