Management Accounting Section Midyear Meeting

Ambiguous Sticks and Carrots: The Effect of Contract Framing and Payoff Ambiguity on Employee Effort

• In Event: Informal Control and Contract Framing (Experimental)

Abstract

This study examines the effect of contract framing on employee effort. Prior research suggests that, due to loss aversion, employees work harder under penalty contracts than under economically equivalent bonus contracts. However, we predict that the motivational advantage of penalty contracts is moderated by a common aspect of real-world contracts: payoff ambiguity. With payoff ambiguity, employees choose how hard to work without knowing exactly how much pay they will receive for a given level of performance. We predict and find that this ambiguity opens the door for employee optimism, which has contrasting effects under each contract frame. Specifically, consistent with our theory, we find that with payoff ambiguity, employees optimistically expect penalties to be small (decreasing the motivation to avoid them) and bonuses to be large (increasing the motivation to receive them). This results in more (less) employee effort when working under a bonus (penalty) contract with ambiguity, relative to a contract with no ambiguity. In further support of our theory, we also find that the predicted effects are stronger for employees who tend to be more versus less optimistic. Overall, when considering payoff ambiguity, penalty contracts may not be as advantageous relative to bonus contracts as previously thought.

Authors

• Joe Burke, Indiana University - Bloomington

• Kristy L Towry, Emory University

• Donald Young, Indiana University

• Jacob Theodore Zureich, Emory University