Salesforce Compensation Plans: A Dynamic Perspective

The agency theory approach to understanding salesforce compensation plans is extended to incorporate the intertemporal nature of the salesperson’s efforts decision, e.e., the effort can potentially change depending on the sales performance up to a given point in time in the accounting period. Under the assumptions considered in this paper, Holmstrom and Milgrom (1987) have shown that the optimal compensation plan is linear in total sales over the accounting period. The comparative statics results obtained here corroborate most of the corresponding results in the literature. In addition, as many new results are obtained. It is shown that commission income as a fraction of total compensation increases with an increase in the effectiveness of sales-effort or an increase in base sales. On the other hand, the salary component of total compensation increases with increase in uncertainty, risk aversion, marginal cost of production, perceived cost of effort or alternative job opportunities for the salesperson. We show that commission rates expressed as a percentage of gross margin are higher for products with higher sales-effort effectiveness or lower levels of uncertainty.