The Informational Advantages of Discretionary Bonus Schemes

This paper explores a possible explanation for the observed use of bonus pool arrangements. Under fairly general conditions, the use of a bonus pool arrangement results in a strict Pareto improvement by enabling an owner to exploit non-contractible information, that might otherwise not be used, to motivate agents. We characterize the optimal bonus pool arrangement and analyze the interdepen dencies which it induces between agents. Our results demonstrate the manner in which the use of non-contractible information via bonus pool schemes distorts the payoffs to agents relative to the case in which the non-contractible information is not used.