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Specific Knowledge and Performance Measurement

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  • Raith, Michael

Abstract

This Paper examines optimal incentives and performance measurement in a setting where an agent has specific knowledge about the consequences of their actions for the principal. I study incentive contracts in which the agent’s compensation can be based on both ‘input’ measures closely related to the agent’s actions, and ‘output’ measures closely related to the principal’s pay-off. I argue that when the agent has specific knowledge (i.e. private information that is difficult to communicate) about how their actions contribute to the principal’s pay-off, output-based pay encourages the agent to use their knowledge while input-based pay does not. I show within a two-task agency model that (partially) output-based compensation is optimal even when the agent’s actions on each task can be measured perfectly. Comparative statics results show how the optimal choice of performance measures and incentives depends on the agent’s knowledge, environmental risk, technological uncertainty, and job complexity. The theory leads to several novel predictions, as well as new explanations for existing empirical findings.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 4262.

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Date of creation: Feb 2004
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Handle: RePEc:cpr:ceprdp:4262

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Related research

Keywords: distortion; incentives; input- vs output-based pay; M52; multitask agency model; performance measurement; risk; specific knowledge;

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References

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  1. Scott Keating, A., 1997. "Determinants of divisional performance evaluation practices," Journal of Accounting and Economics, Elsevier, vol. 24(3), pages 243-273, December.
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Citations

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Cited by:
  1. Ben-Ner, Avner & Kong, Fanmin & Lluis, Stéphanie, 2012. "Uncertainty, task environment, and organization design: An empirical investigation," Journal of Economic Behavior & Organization, Elsevier, vol. 82(1), pages 281-313.
  2. Bouwens, J.F.M.G. & Lent, L.A.G.M. van, 2006. "Assessing the Performance of Business Unit Managers," Discussion Paper 2006-92, Tilburg University, Center for Economic Research.
  3. Anthony M. Marino & Ján Zábojník, 2008. "Work-related perks, agency problems, and optimal incentive contracts," RAND Journal of Economics, RAND Corporation, vol. 39(2), pages 565-585.
  4. Engert, Andreas & Goldlücke, Susanne, 2013. "Why agents need discretion: The business judgment rule as optimal standard of care," Working Papers 13-04, University of Mannheim, Department of Economics.
  5. Wruck, Karen H. & Wu, YiLin, 2009. "Relationships, corporate governance, and performance: Evidence from private placements of common stock," Journal of Corporate Finance, Elsevier, vol. 15(1), pages 30-47, February.
  6. Ana-Maria Godeanu, 2012. "The antecedents of satisfaction with pay in teams: do performance-based compensation and autonomy keep team-members satisfied?," Eastern Journal of European Studies, Centre for European Studies, Alexandru Ioan Cuza University, vol. 3, pages 145-168, June.
  7. Shi, Lan, 2011. "Respondable risk and incentives for CEOs: The role of information-collection and decision-making," Journal of Corporate Finance, Elsevier, vol. 17(1), pages 189-205, February.
  8. Kato, Takao & Kauhanen, Antti & Salmi, Julia, 2013. "Empirical Evidence on the Dynamics of Incentive Plans," ETLA Working Papers 20, The Research Institute of the Finnish Economy.
  9. Kauhanen, Antti & Napari, Sami, 2010. "Performance Measurement and Incentive Plans," Discussion Papers 1216, The Research Institute of the Finnish Economy.
  10. DeVaro, Jed, 2011. "Using "opposing responses" and relative performance to distinguish empirically among alternative models of promotions," MPRA Paper 35175, University Library of Munich, Germany.
  11. Jed Devaro & Fidan Ana Kurtulus, 2011. "An Empirical Analysis of Risk, Incentives and The Delegation of Worker Authority," UMASS Amherst Economics Working Papers 2011-13, University of Massachusetts Amherst, Department of Economics.
  12. Chen, Bo, 2012. "All-or-nothing payments," Journal of Mathematical Economics, Elsevier, vol. 48(3), pages 133-142.
  13. DeVaro, Jed & Prasad, Suraj, 2013. "The Relationship Between Delegation and Incentives Across Occupations: Evidence and Theory," Working Papers 2013-05, University of Sydney, School of Economics.

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