Setting incentives for managers: Incentive compatibility, similarity rule, and goal congruence

Abstract

The terms ‘incentives’ and ‘incentive compatibility’ are widely used in economics. Incentives are an important object in managerial accounting. Nevertheless—or just because?—there is a notable ambiguity in their exact meaning, especially of ‘incentive compatibility’. Likewise, in many cases it is not clear whether ‘setting the right incentives’ means ‘ensuring incentive compatibility’ or something else. This chapter depicts some important relationships between different definitions in differing economic models dealing with incentives, starting with the game theoretic definitions of incentive compatibility.