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ABSTRACT: This paper reports the results of an experiment examining the effect of the framing of incentive contracts on individual behavior. We examine two budget-based incentive contracts that, though economically equivalent, are framed differently. Previous research documents that individuals prefer bonus-framed to penalty-framed contracts (Luft 1994; Hannan et al. 2005). We explore whether these preferences affect effort expended on a task where increased effort results in increased performance. In addition, we test whether these preferences motivate effort differentially in the presence and absence of an effective financial incentive for performance. Consistent with prospect theory predictions, results indicate the penalty-framed contract motivates higher task performance than the bonus-framed contract for individuals whose performance falls within the bonus or penalty range (i.e., where financial incentives are effective in motivating performance). Performance did not differ according to contract frame for individuals whose performance enabled them to receive the maximum payment or for individuals whose performance resulted in them receiving the minimum payment (i.e., where financial incentives were not effective in motivating performance). Although prior research indicates contract framing affects contract preferences, our results indicate these preferences may not result in differences in individual performance unless effective financial incentives are also utilized. ©2008 American Accounting Association