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Limited Liability and the Risk-Incentive Relationship

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  • Budde, Jörg
  • Kräkel, Matthias

Abstract

Several empirical findings have challenged the traditional view on the trade-off between risk and incentives. By combining risk aversion and limited liability in a standard principal-agent model the empirical puzzle on the positive relationship between risk and incentives can be explained. Increasing risk leads to a less informative performance signal. Under limited liability, the principal may optimally react by increasing the weight on the signal and, hence, choosing higher-powered incentives.

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Bibliographic Info

Paper provided by Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich in its series Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems with number 232.

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Date of creation: Mar 2008
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Handle: RePEc:trf:wpaper:232

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Keywords: moral hazard; limited liability; risk-incentive relationship;

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