Incentive Contract Advantages and Disadvantages

Incentive contracts are agreements between two parties that give rewards to one party if certain goals are met. These types of contracts are often used in business relationships, where the party providing the service can receive an additional payment if they meet or exceed established benchmarks. While incentive contracts can offer many advantages, they can also have some drawbacks that must be considered before entering into such an agreement.

Advantages of Incentive Contracts

1. Increased Motivation: Incentive contracts can help to motivate the service provider to work harder and achieve better results. This is because they know that their efforts will be rewarded with additional compensation.

2. Better Results: With the added motivation, incentive contracts can lead to better results for both parties involved. The service provider is incentivized to deliver high-quality work, and the client benefits from the improved performance.

3. Cost Savings: Incentive contracts can help to reduce costs by offering a financial incentive to the service provider. The provider is motivated to complete the work more efficiently and effectively, resulting in cost savings for both parties.

4. Risk-Sharing: Incentive contracts can also help to share risk between the client and the service provider. By offering a financial incentive for achieving certain objectives, the client can reduce the risk of poor performance by the service provider.

Disadvantages of Incentive Contracts

1. Potential for Conflict: Incentive contracts can create conflicts between the client and the service provider. If the desired results are not achieved, the service provider may feel that they have not been adequately compensated, which can lead to disputes.

2. Difficult to Measure Results: It can be challenging to determine whether the service provider has achieved the desired results. This can lead to disagreements over the amount of the incentive payment or whether the objectives were met.

3. Potentially Unethical Behavior: Incentive contracts can create an environment where unethical behavior is more likely. For example, the service provider may cut corners to achieve the desired results or misrepresent their efforts to receive the incentive payment.

4. Limited Control: Incentive contracts can limit the client`s control over the service provider`s actions. The provider may focus on meeting the objectives outlined in the contract to the exclusion of other, more important tasks.


Incentive contracts can offer many advantages to both the client and the service provider. They can increase motivation, lead to better results, reduce costs, and share risk. However, they can also have disadvantages, such as the potential for conflicts, difficulty in measuring results, potential for unethical behavior, and limited control. As with any contract, it is essential to carefully consider the advantages and disadvantages before entering into such an agreement.