The effects of bonus vs. penalty incentives in a laboratory market setting

Abstract

Prior research (Luft 1994) has shown in a between-subjects laboratory setting that individual decision makers are more likely to accept an employment contract containing an incentive described as a bonus than one with identical payoffs described in penalty terms. Each of these budget-based contracts has exactly two potential payoffs; which payoff a given subject receives depends on whether the subject's task performance meets (or exceeds) the budget. Luft's (1994) results are interesting because they demonstrate in an individual decision-making setting the empirical invalidity of the assumption in most formal economic analyses that people are indifferent between such alternative verbal descriptions. However, there is continuing debate and mixed evidence on the issue of whether decisional behavior evident in individual decision-making settings is also evident in market settings. This research tests whether a preference for bonus incentives characterizes equilibrium in a laboratory setting in which subjects serving as employers in half (the other half) of the markets compete with each other to attract subjects serving as workers by offering them bonus (penalty) contracts. Worker subjects are always free to choose a fixed-pay contract. Market outcomes were consistent with the prediction of no significant bonus preference evident at equilibrium.