The use of incentive contracting and firm reputation

Following the vast amount of theoretical research demonstrating the benefits of incentive contracting (Jensen and Meckling, 1976; Farley, 1964; Weinberg, 1975; Srinivasan, 1981; Basu et al., 1985, Bryan et al., 2006; Stiffler, 2006; Chu, 2006), corporations have embraced and significantly increased their use of incentive contracts such as commission on sales, over that past decade. While corporations have increased the use of incentive contracting, they have simultaneously expressed increased interest in maintaining or improving the reputation of their firm. This research demonstrates that the two goals may be incongruous, that, in contrast to previous research, the use of incentive contracting may not align the interests of management and sales staff and may expose the corporation to increased reputation risk. Specifically, we incorporate Finnerty's (2005) compensation model into a multilevel asymmetric information model and demonstrate that a salesperson's incentive to increase reputational risk by misrepresenting the product or service of the firm is a function of the existence of asymmetric information between the salesperson and the customer, for example customer knowledge base, the inability of management to monitor a salesperson's actions, the lack of a timely penalty for a salesperson's aberrant actions, and the relative level of salesperson's commission to base compensation. © 2010 Macmillan Publishers Ltd.