The Incentive and Selection Roles of Sales Force Compensation Contracts

Designing compensation plans with an appropriate level of incentives is a key decision faced by managers of direct sales forces. The authors use data on individual salesperson compensation contracts to show that firms design their pay plans to both discriminatingly select (i.e., attract and retain) salespeople and provide them with the right level of incentives. Consistent with standard agency arguments, the authors find that firms use higher-powered incentives as the importance of agent effort increases. At the same time, the authors find strong support for the selection role of these contracts. Specifically, agents with greater selling ability and lower risk aversion are associated with jobs offering higher-powered incentives. Finally, consistent with prior findings on incentive contracts, the authors find no support for the insurance implication of the typical agency model. The authors rule out alternative explanations for this anomalous result and find that the selection role of contracts best explains the result in their context.