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Task-specific effort costs and the trade-off between risk and efficiency

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Marisa Ratto ()

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Abstract

This paper considers a principal-agent model in which an agent chooses the level of effort on two tasks that determine two separate outputs. The level of effort is private information to the agent. We examine the relationship between risk and incentives when the agent has a preference towards one of the two tasks. This is modelled by the assumption that the cost of effort is task specific. We show that when outputs are not perfectly measurable, even if the measurement errors have the same variance, the principal has to set different marginal incentives. This is because the agent tries to spread the risk, created by imperfect output measurement, by distributing more evenly his effort between the two tasks, thereby moving away from an efficient allocation of effort. If the two outputs are measured with different precision, it can be optimal for the principal to set higher marginal incentives on the output measured with less precision. Hence the standard result of the negative correlation between risk and incentives does not necessarily hold.

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File URL: http://www.bris.ac.uk/Depts/CMPO/workingpapers/wp143.pdf
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Publisher Info
Paper provided by Department of Economics, University of Bristol, UK in its series The Centre for Market and Public Organisation with number 06/143.

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Length: 13 pages
Date of creation: Mar 2006
Date of revision:
Handle: RePEc:bri:cmpowp:06/143

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Related research
Keywords: uncertainty; risk spreading; efficiency; incentives;

Find related papers by JEL classification:
D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
M52 - Business Administration and Business Economics; Marketing; Accounting - - Personnel Economics - - - Compensation and Compensation Methods and Their Effects

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Itoh, Hideshi, 1992. "Cooperation in Hierarchical Organizations: An Incentive Perspective," Journal of Law, Economics and Organization, Oxford University Press, vol. 8(2), pages 321-45, April.
  2. Itoh, Hideshi, 1991. "Incentives to Help in Multi-agent Situations," Econometrica, Econometric Society, vol. 59(3), pages 611-36, May. [Downloadable!] (restricted)
  3. Jensen, Michael C & Murphy, Kevin J, 1990. "Performance Pay and Top-Management Incentives," Journal of Political Economy, University of Chicago Press, vol. 98(2), pages 225-64, April. [Downloadable!] (restricted)
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  4. Glenn MacDonald & Leslie M. Marx, 2001. "Adverse Specialization," Journal of Political Economy, University of Chicago Press, vol. 109(4), pages 864-899, August. [Downloadable!] (restricted)
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