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This paper studies the nature of incentive contracts between a risk‐neutral principal and a risk‐neutral agent under the constraint that the agent's liability is limited. A necessary and sufficient condition is derived for the existence of a first‐best contract under this constraint, and a bonus‐based contract is shown to be the most efficient contractual form. Implications of bonus contracts are also discussed.
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Son Ku Kim (1997) studied this question.
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