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UBC Theses and Dissertations

Non-monetary and informal compensation in agency settings Adithipyangkul, Pattarin

Abstract

In the prior agency literature, the optimal compensation contracts generally specify cash payments that are functions of verifiable performance measures, which can be enforced by the courts. However, the compensation we observe in the real world often includes non-cash components like fringe benefits, gifts, etc. In addition, there are often unwritten (informal) contracts based on personal agreements between a boss and an employee, or between colleagues. These unwritten contracts are generally not enforced by the courts, but they can shape employees' expectations, and hence influence their behavior, as long as the agent believes there is positive probability the boss or colleague will abide by the agreement. This dissertation examines the optimal composition and formality of compensation contracts in agency settings. Three assumptions which distinguish it from the prior agency literature based on cash compensation include (i) not all consumption goods are available from the market (the principal is the only source of some goods), (ii) the agent's productivity is affected by her consumption, and (iii) the principal have a cost advantage in providing some goods. The optimal contracts in different settings are derived. The characteristics of the optimal contract are determined by the characteristics of the good, and the characteristic of the principal's cost advantage (if any). If the agent has private, pre-contract information, the optimal contracts are also determined by the kind of private information the agent has. To explain the use of informal contracts, this dissertation relaxes the assumption that all actions can be manipulated or controlled by a formal mechanism, like a written contract, an audit, etc. This dissertation considers an undesirable action that is beneficial to the agent but is costly to the principal, which cannot be deterred by a formal mechanism. Examples of this kind of action include strikes and employee litigation. An employee opportunistically exercises her rights under the labour law, and this cannot be deterred by a formal mechanism. This thesis shows that informal contracting may be able to deter these undesirable actions, so that the principal is better off leaving the contract unwritten.

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