Performance-based compensation vs. guaranteed compensation: contractual incentives and performance

Top management from retail banks must delegate authority to lower-level managers to operate branches and service centers. Doing so, they must navigate through conflicts of interest, asymmetric information and limited monitoring in designing compensation plans for such agents. Pursuant to this delegation, the banks adopt a system of performance targets and incentives to align the interests of senior management and unit managers. This paper evaluates the causal relationship between performance-based salaries and managers’ effective performance. We use a fixed effects estimator to analyze an unbalanced panel of data from one of the largest Brazilian retail banks during the period from January 2007 to June 2009. The results indicate that agents with guaranteed variable salary contracts demonstrate inferior performance compared with agents who have performance-based compensation packages. We conclude that there is a moral hazard that can be observed in the behavior of agents who are subject to guaranteed variable salary contracts.

Trust-based trade

There is substantially more trade within national borders than across borders. An important explanation for this fact is the weak enforcement of international contracts. We develop a model in which agents build reputations to overcome this institutional failure. The model describes the interplay between institutional quality, reputations and the dynamics of international trade. It also rationalizes several empirical regularities. We find that history matters for trade volumes, but that its effects vary with the institutional setting of the country. The same is true for the efticacy of trade liberalization programs. Moreover, while stricter enforcement of contracts enhances trade in the short run, it makes it harder for individual traders to develop good reputations. We show that this indirect negative effect may produce an "institutional trap": for sufliciently low initial levels of contract enforcement, a small tightening in enforcement reduces future trade fiows. We find also that search frictions aggravate the problems created by weak enforceability of contracts, even if they impose no direct cost on agents. The model allows extensions in several directions. We outline two of them, indicating how one could study transnational networks and the effects of firm heterogeneity within our structure.