I<scp>ncentive</scp> C<scp>ontracting</scp> U<scp>nder</scp> L<scp>imited</scp> L<scp>iability</scp>

Abstract

We examine the nature of incentive schemes between the principal and the risk‐neutral agent in the presence of the agent's limited liability and ex ante action choice. We consider alternative schemes when a simple rental contract is infeasible due to the limited liability of the agent and study the effectiveness of a performance bonus scheme in achieving the first‐best outcome. We also discuss some implications of such schemes in real practices.