Managerial Beliefs and Incentive Policies

Abstract

This article examines incentive contracts under moral hazard when a principal and agents disagree about the likelihood that a task will succeed. The direction of disagreement alters the effectiveness of monetary incentives. The principal's optimal contract is a relative performance evaluation when she is more optimistic than the agents, and a joint performance evaluation when she is less optimistic. We further show why disagreement may prevail in organizations by considering a simple job assignment problem.