To Give Up or Not to Give Up: The Effect of Contract Frame and Target Difficulty on Effort Provision and Performance

Abstract

Bonus contracts are often used in practice but can create incentives for gaming. Penalty contracts are growing in popularity as they can provide the benefit of motivating greater effort than bonus contracts. However, we do not have a clear understanding of how individuals are motivated by penalty contracts at different target levels in relation to bonus contracts. We experimentally evaluate the effects of contract frame and target difficulty on effort provision and performance. Building from Prospect Theory, we predict and find that subordinates working under a penalty contract show greater giving up behavior than those working under a bonus contract when given a high target, but not with a low target. Notably, however, subordinates who do not give up show higher performance under a penalty compared to a bonus contract when given a high target, but lower performance when working towards a low target.