On the Optimality of Linear Contracts to Induce Goal-Congruent Investment Behavior

Abstract

It has become increasingly popular in practice to implement incentive systems that create goal-congruent investment behaviour between central and divisional management. In the following paper, it is shown that only linear contracts enable goal-congruent investment decisions if central management does not have information about the investment project. This might cast a new light on why linear compensation schemes are often used in practice.