Binary Payment Schemes: Moral Hazard and Loss Aversion
AbstractWe modify the principal-agent model with moral hazard by assuming that the agent is expectation-based loss averse according to Köszegi and Rabin (2006, 2007). The optimal contract is a binary payment scheme even for a rich performance measure, where standard preferences predict a fully contingent contract. The logic is that, due to the stochastic reference point, increasing the number of different wages reduces the agent’s expected utility without providing strong additional incentives. Moreover, for diminutive occurrence probabilities for all signals the agent is rewarded with the fixed bonus if his performance exceeds a certain threshold.
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Bibliographic InfoPaper provided by Max Planck Institute for Research on Collective Goods in its series Working Paper Series of the Max Planck Institute for Research on Collective Goods with number 2010_38.
Date of creation: Sep 2010
Date of revision:
Other versions of this item:
- Fabian Herweg & Daniel Muller & Philipp Weinschenk, 2010. "Binary Payment Schemes: Moral Hazard and Loss Aversion," American Economic Review, American Economic Association, vol. 100(5), pages 2451-77, December.
- D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
- M12 - Business Administration and Business Economics; Marketing; Accounting - - Business Administration - - - Personnel Management; Executives; Executive Compensation
- M52 - Business Administration and Business Economics; Marketing; Accounting - - Personnel Economics - - - Compensation and Compensation Methods and Their Effects
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-11-20 (All new papers)
- NEP-CTA-2010-11-20 (Contract Theory & Applications)
- NEP-UPT-2010-11-20 (Utility Models & Prospect Theory)
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