Controlled experiments provided evidence that (1) employees are more likely to accept incentive contracts described in bonus terms than contracts that appear identical except for being described in penalty terms, and (2) when employees' judgment of their past performance is dependent on memory, the preference for bonus over penalty contracts increases with experience. These phenomena are explained in terms of the human information processing costs of communicating and evaluating the contract terms, and further implications are drawn for the empirical study of contracting.

Cost overruns on multi-period projects are large and frequent in natural environments. Reasons for these overruns include cost understatements in initial project proposals and escalation of commitment to projects when initial actual costs turn out to be higher than expected. Prior literature has suggested, and some firms have implemented, a device that limits escalation and thus potentially reduces cost overruns: changing decision makers (superiors) so that the manager who approves continuation of a project is not the same individual who approved the project initially. We provide theoretical explanations and experimental evidence about how changing versus continuing superiors affect the underestimates of cost in initial project proposals. We find that although changing superiors, as expected, are more likely than are continuing superiors to react skeptically to continuation proposals when first-period cost overruns have occurred, this does not reduce initial cost understatements and overruns. On the contrary, in our setting it leads to greater initial understatements and overruns. Subordinates anticipate that new superiors will be more critical of their projects; hence, they discount later-period payoffs and focus on gaining initial funding by providing understated cost estimates.

[This paper examines experienced managers' judgments about the effects of market price and accounting profit information on negotiated transfer prices. Conventional economic arguments predict that market price should determine negotiated transfer prices by determining reservation prices for parties with outside options. We found, however, that experienced managers expected the influence of market price to be limited by divisional managers' concern about how their profits compare with each other. While market price did affect managers' reservation-price and transfer-price estimates, its influence was significantly less when market price resulted in a more unequal ("unfair") distribution of profits between divisions. Profit comparisons also affected the judgments that determine the efficiency of the bargaining process. We found that as market price diverged from a price that offered equal profits to both divisions, both variance and bias in managers' price estimates increased, indicating that it would be harder to reach agreement on a transfer price.]

This paper examines experienced managers' judgments about the effects of market price and accounting profit information on negotiated transfer prices. Conventional economic arguments predict that market price should determine negotiated transfer prices by determining reservation prices for parties with outside options. We found, however, that experienced managers expected the influence of market price to be limited by divisional managers' concern about how their profits compare with each other. While market price did affect managers' reservation-price and transfer-price estimates, its influence was significantly less when market price resulted in a more unequal ("unfair") distribution of profits between divisions. Profit comparisons also affected the judgments that determine the efficiency of the bargaining process. We found that as market price diverged from a price that offered equal profits to both divisions, both variance and bias in managers' price estimates increased, indicating that it would be harder to reach agreement on a transfer price.