Bonus pools and the informativeness principle

- Bonus contracts are frequently used in practice.
- We show that contracts may be improved by combining worker compensation via a bonus pool.
- Pooling bonuses can reduce worker' rents and increase the set of implementable effort levels.
- Our results hold even though workers' outputs are technically and stochastically independent.

Previous work on moral-hazard problems has shown that, under certain conditions, bonus contracts create optimal individual incentives for risk-neutral workers. In our paper we demonstrate that, if a firm employs at least two workers, it may further benefit from combining worker compensation via a bonus-pool contract and relative performance evaluation. Such combination leads to saved rents under a wide class of luck distributions. In addition, if the employer is wealth-constrained, complementing individual bonus contracts by the possibility of pooling bonuses can increase the set of implementable effort levels. All our results hold even though workers' outputs are technically and stochastically independent so that, in view of Holmstrom's informativeness principle, individual bonus contracts would be expected to dominate bonus-pool contracts.