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Task Difficulty, Performance Measure Characteristics, and the Trade-Off between Insurance and Well-Allocated Effort

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  • Wendelin Schnedler

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Abstract

When designing incentives for a manager, the trade-off between insurance and a "good" allocation of effort across various tasks is often identified with a trade-off between the responsiveness (sensitivity, precision, signal-noise ratio) of the performance measure and its similarity (congruity, congruence) to the benefit of the manager's employer. A necessary condition for the trade-off between responsiveness and similarity to be meaningful is that a perfectly congruent measure creates a higher benefit than an equally responsive non-congruent measure. We show that this condition is met if and only if all tasks are exactly equally difficult and there are no spill-overs or synergies across tasks. This means that for most practical purposes, notions of responsiveness and similarity are not informative about the tradeoff between insurance and allocation. In order to understand this trade-off, task difficulty has also to be taken into account.

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File URL: http://www.bris.ac.uk/Depts/CMPO/workingpapers/wp147.pdf
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Bibliographic Info

Paper provided by Department of Economics, University of Bristol, UK in its series The Centre for Market and Public Organisation with number 06/147.

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Length: 16 pages
Date of creation: May 2006
Date of revision:
Handle: RePEc:bri:cmpowp:06/147

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Keywords: hidden action; multitasking; incentives;

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  1. George Baker, 2000. "The Use of Performance Measures in Incentive Contracting," American Economic Review, American Economic Association, vol. 90(2), pages 415-420, May.
  2. Holmstrom, Bengt & Milgrom, Paul, 1987. "Aggregation and Linearity in the Provision of Intertemporal Incentives," Econometrica, Econometric Society, vol. 55(2), pages 303-28, March.
  3. Canice Prendergast, 1999. "The Provision of Incentives in Firms," Journal of Economic Literature, American Economic Association, vol. 37(1), pages 7-63, March.
  4. Macho-Stadler, Ines & Perez-Castrillo, J. David, 2001. "An Introduction to the Economics of Information: Incentives and Contracts," OUP Catalogue, Oxford University Press, edition 2, number 9780199243259.
  5. Chaim Fershtman & Kenneth L Judd, 1984. "Equilibrium Incentives in Oligopoly," Discussion Papers 642, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
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