Charity, incentives, and performance

•We propose that donations to charity can improve firm performance.•The positive effect of donations to charity stems from reduced moral hazard.•We run principal-agent experiments where principals make donations to charity.•The results show that profits are higher when principals work on behalf of a charity.•Only in charity treatments do agents respond to effort levels suggested by principals.

We propose that donating profits to charity may improve firm performance through reduced moral hazard and increased effort in incomplete contract environments. This proposition is tested and confirmed in an incomplete contract principal-agent laboratory experiment where principals' profits are donated to charity. The results show that both principals and agents have higher earnings in treatments where principals are working on behalf of a charity. Only in the charity treatments do agents respond positively to the effort levels suggested by the principals, and do higher requested levels of effort result in higher principal earnings.