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Common Shocks and Relative Compensation Schemes

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Author Info
Magill, Michael (U of Southern California)
Quinzii, Martine (U of California, Davis)

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Abstract

This paper studies qualitative properties of an optimal contract in a multi-agent setting in which agents are subject to a common shock. We derive a necessary and sufficient condition for the optimal reward of an agent to be a decreasing (increasing) function of the outputs of the other agents, under the assumption that the agents' outputs are informative signals of the value of the common shock. The condition is that the likelihood ratio of a given outcome with high versus low effort be a decreasing (increasing) function of the common shock. We derive conditions on the way the common shock affects the marginal product of effort under which the likelihood ratio is decreasing for all output levels, or increasing for some output levels and decreasing for others.

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Paper provided by University of California at Davis, Department of Economics in its series Working Papers with number 05-2.

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Date of creation: Dec 2004
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Handle: RePEc:ecl:ucdeco:05-2

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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. Edward P. Lazear & Sherwin Rosen, 1981. "Rank-Order Tournaments as Optimum Labor Contracts," NBER Working Papers 0401, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Rogerson, William P, 1985. "The First-Order Approach to Principal-Agent Problems," Econometrica, Econometric Society, vol. 53(6), pages 1357-67, November. [Downloadable!] (restricted)
  3. Robert Gibbons & Kevin Murphy, 1989. "Relative Performance Evaluation for Chief Executive Officers," Working Papers 628, Princeton University, Department of Economics, Industrial Relations Section.. [Downloadable!]
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  4. Green, Jerry R & Stokey, Nancy L, 1983. "A Comparison of Tournaments and Contracts," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 349-64, June. [Downloadable!] (restricted)
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  5. Robert Gibbons & Kevin J. Murphy, 1990. "Relative performance evaluation for chief executive officers," Industrial and Labor Relations Review, ILR Review, ILR School, Cornell University, vol. 43(3), pages 30-51, February.
  6. Paul R. Milgrom, 1981. "Good News and Bad News: Representation Theorems and Applications," Bell Journal of Economics, The RAND Corporation, vol. 12(2), pages 380-391, Autumn. [Downloadable!] (restricted)
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  7. Jewitt, Ian, 1988. "Justifying the First-Order Approach to Principal-Agent Problems," Econometrica, Econometric Society, vol. 56(5), pages 1177-90, September. [Downloadable!] (restricted)
  8. Mookherjee, Dilip, 1984. "Optimal Incentive Schemes with Many Agents," Review of Economic Studies, Blackwell Publishing, vol. 51(3), pages 433-46, July. [Downloadable!] (restricted)
  9. Bengt Holmstrom, 1982. "Moral Hazard in Teams," Bell Journal of Economics, The RAND Corporation, vol. 13(2), pages 324-340, Autumn. [Downloadable!] (restricted)
  10. Murphy, Kevin J., 1999. "Executive compensation," Handbook of Labor Economics, in: O. Ashenfelter & D. Card (ed.), Handbook of Labor Economics, edition 1, volume 3, chapter 38, pages 2485-2563 Elsevier. [Downloadable!] (restricted)
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  1. Michael Magill & Martine Quinzii, 2005. "An Equilibrium Model of Managerial Compensation," IEPR Working Papers 05.22, Institute of Economic Policy Research (IEPR). [Downloadable!]
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