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The B.E. Journal of Theoretical Economics

Editor-in-Chief: Schipper, Burkhard

Ed. by Fong, Yuk-fai / Peeters, Ronald / Puzzello , Daniela / Rivas, Javier / Wenzelburger, Jan

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Costly Rewards and Punishments

Frances Z. Xu Lee
  • Corresponding author
  • Quinlan School of Business, Loyola University of Chicago, 16 E Pearson St, Chicago, IL 60611, USA
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Published Online: 2019-09-17 | DOI: https://doi.org/10.1515/bejte-2018-0131


To punish an agent, the principal often incurs costs. I study a principal’s least costly reward and punishment scheme for an agent whose effort the principal cannot observe. I find the principal’s cost is sometimes minimized by using both costly rewards and costly punishments because (1) the agent has an outside option, or (2) a principal without commitment ability repeatedly interacts with the agent. I also find that when an agent’s effort is better at increasing the probability of a good outcome for the principal, the agent’s payoff may decrease, because the principal replaces rewards with punishments.

Keywords: costly punishment; principal-agent; moral hazard; outside option; credibility

JEL Classification: D23; L20; D86


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About the article

Published Online: 2019-09-17

Citation Information: The B.E. Journal of Theoretical Economics, Volume 20, Issue 1, 20180131, ISSN (Online) 1935-1704, DOI: https://doi.org/10.1515/bejte-2018-0131.

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