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Limited Liability and the Risk-Incentive Relationship

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  • Jörg Budde

    ()

  • Matthias Kräkel

    ()

Abstract

Several empirical findings have challenged the traditional view on the trade-off between risk and incentives. By combining risk aversion and limited liability in a standard principal-agent model the empirical puzzle on the positive relationship between risk and incentives can be explained. Increasing risk leads to a less informative performance signal. Under limited liability, the principal may optimally react by increasing the weight on the signal and, hence, choosing higher-powered incentives.

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Bibliographic Info

Paper provided by University of Bonn, Germany in its series Bonn Econ Discussion Papers with number bgse6_2008.

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Length: 13
Date of creation: Mar 2008
Date of revision:
Handle: RePEc:bon:bonedp:bgse6_2008

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Postal: Bonn Graduate School of Economics, University of Bonn, Adenauerallee 24 - 26, 53113 Bonn, Germany
Fax: +49 228 73 6884
Web page: http://www.bgse.uni-bonn.de

Related research

Keywords: moral hazard; limited liability; risk-incentive relationship Abstract: Several empirical findings have challenged the traditional view on the trade-off between risk and incentives. By combining risk aversion and limited liability in a standard principal-agent model the empiri- cal puzzle on the positive relationship between risk and incentives can be explained. Increasing risk leads to a less informative performance signal. Under limited liability; the principal may optimally react by in- creasing the weight on the signal and; hence; choosing higher-powered incentives.;

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