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Recall (a) Alchian and Demsetz’ emphasis on the difficulty of observing individual contributions to team-based production, (b) Williamson’s emphasis on relational contracts being maintained largely by mutual interest in their preservation, (c) the reputational consequences of defection, and (d) Kerr’s attribution of at least part of the reason for unintended consequences of “you get what you pay for” contracts to an overemphasis on quantitative measures. Dealing with these issues, Gibbons notes that in many cases an individual’s contribution to firm value is “observable but not verifiable” thus requiring subjective measures and likens a relational incentive contract to a repeated trial game in which the employer pays a fixed base s and a bonus, B, if performance is rated “high.” Of course subjective measures are more vulnerable to “defecting action” by the manager and thus we need to understand why and under what conditions they will likely be scrupulously observed. Which statement below is untrue in the repeated game analysis of subjective measures of performance?
a) Unlike the single period model, the firm has an incentive to pay an earned bonus (not defect) if it fears defecting would harm its reputation and chill further efforts by employees to achieve high performance
b) The decision to evaluate fairly and to pay the bonus is stronger if the expected present value of increased future profits through continued efforts by employees outweighs the cost of paying the bonus today.
c) Future profits are valued more highly when interest rates are low and hence managers will, ceteris paribus, be more inclined to evaluate fairly and pay the bonus when low interest rates are expected
d) In an era of expected high interest rates, it will be less likely that high performance today can create enough future profit to justify a very large bonus and defection becomes more likely
e) None of the above are untrue
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