Contract Framing, Expected Disappointment, and Effort: The Moderating Role of External Locus of Control

Abstract

Understanding when incentive contracts are effective is important for organizations. Prior research documents that while employees generally prefer to work under contracts that include bonuses, employees exert more effort under economically equivalent penalty contracts. One reason for this is that penalties cause employees to experience greater expected disappointment than do bonuses. This study extends prior research in this area by documenting that external locus of control (ELOC), an individual characteristic, helps explain how different employees respond to incentive contracts. We predict and find that, compared to individuals with higher ELOC, individuals with lower ELOC are less susceptible to contract frame-induced differences in expected disappointment and not as motivated by penalty contracts compared to bonus contracts. This finding extends theory on contract framing and has important implications for organizations. Our results suggest that penalty provisions are most efficacious at lower ranks in the organization where higher ELOC is more common.