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Loss Aversion, Stochastic Compensation, and Team Incentives

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  • Kohei Daido

    ()
    (School of Economics, Kwansei Gakuin University)

  • Takeshi Murooka

    ()
    (Department of Economics, University of California, Berkeley)

Abstract

We investigate moral-hazard problems with limited liability where agents have expectation-based reference-dependent preferences. We show that stochastic compensation for low performance can be optimal. Because of loss aversion, the agents have first-order risk aversion to wage uncertainty. This causes the agents to work harder when their low performance is stochastically compensated. We also examine team incentives for credibly employing such stochastic compensation. In an optimal contract, low- and high-performance agents are equally rewarded if most agents achieve high performance. Team incentives can be optimal even when there are only two agents and the degree of loss aversion is not large.

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File URL: http://192.218.163.163/RePEc/pdf/kgdp107.pdf
File Function: First version, 2013
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Bibliographic Info

Paper provided by School of Economics, Kwansei Gakuin University in its series Discussion Paper Series with number 107.

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Length: 37 pages
Date of creation: Jul 2013
Date of revision: Jul 2013
Handle: RePEc:kgu:wpaper:107

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Keywords: Moral Hazard; Loss Aversion; Stochastic Compensation; Team Incentives; Reference-Dependent Preferences;

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