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Limited Liability and the Risk-Incentive Relationship

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Author Info
Jörg Budde () (University of Bonn, Adenauerallee 24-42, D-53113 Bonn, Germany, tel: +49 228 739247, fax: +49 228 735048, e-mail: Joerg.Budde@uni-bonn.de.)
Matthias Kräkel () (University of Bonn, Adenauerallee 24-42, D-53113 Bonn, Germany, tel: +49 228 733914, fax: +49 228 739210, e-mail: m.kraekel@uni-bonn.de.)

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Abstract

Several empirical ï¬ndings 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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Publisher Info
Paper provided by SFB/TR 15 Governance and the Efficiency of Economic Systems, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich in its series Discussion Papers 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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Related research
Keywords: moral hazard; limited liability; risk-incentive relationship;

Other versions of this item:

Find related papers by JEL classification:
D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information
D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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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. Dominique M. Demougin & Devon A. Garvie, 1991. "Contractual Design with Correlated Information under Limited Liability," RAND Journal of Economics, The RAND Corporation, vol. 22(4), pages 477-489, Winter. [Downloadable!] (restricted)
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  2. Serfes, Konstantinos, 2005. "Risk sharing vs. incentives: Contract design under two-sided heterogeneity," Economics Letters, Elsevier, vol. 88(3), pages 343-349, September. [Downloadable!] (restricted)
  3. Michael Raith, 2003. "Competition, Risk, and Managerial Incentives," American Economic Review, American Economic Association, vol. 93(4), pages 1425-1436, September. [Downloadable!]
  4. Demougin, Dominique & Fluet, Claude, 2001. "Monitoring versus incentives," European Economic Review, Elsevier, vol. 45(9), pages 1741-1764, October. [Downloadable!] (restricted)
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