In this sixth part of the series on designing effective pay-for-performance plans, the focus is informal agreements and implicit incentives. Most employers and employees interact with each other not just once but repeatedly over time. For example, an employee typically works for the same employer for multiple months or years so that an employer and employee may form what economists call a
relational contract where both parties have an informal understanding about each other’s obligations. If both parties are satisfied with the working relationship and believe that it is both productive and profitable, then the need for explicit pay-for-performance plans is greatly reduced. If the employee consistently underperforms, then the relationship may unravel and the employer may terminate the relationship and/or withhold other implicit obligations. This can motive employees to perform even in the absence of an explicit pay-for-performance plan.