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Subjective Evaluation versus Public Information

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  • Bester, Helmut
  • Münster, Johannes

Abstract

This paper studies a principal-agent relation in which the principal's private information about the agent's effort choice is more accurate than a noisy public performance measure. For some contingencies the optimal contract has to specify ex post inefficiencies in the form of inefficient termination (firing the agent) or third-party payments (money burning). We show that money burning is the less efficient incentive device: it is used at most in addition to firing and only if the loss from termination is small. Under an optimal contract the agent's wage may depend only on the principal's report and not on the public signal. Nonetheless, public information is valuable as it facilitates truthful subjective evaluation by the principal.

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File URL: http://epub.ub.uni-muenchen.de/15340/1/399.pdf
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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 399.

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Date of creation: 24 May 2013
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Handle: RePEc:trf:wpaper:399

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Keywords: Subjective evaluation; moral hazard; termination clauses; third-party payments;

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  1. Bester, Helmut & Krähmer, Daniel, 2008. "Exit Options in Incomplete Contracts with Asymmetric Information," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 251, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
  2. Matthias Lang, 2014. "Communicating Subjective Evaluations," CESifo Working Paper Series 4830, CESifo Group Munich.
  3. Canice Prendergast, 1999. "The Provision of Incentives in Firms," Journal of Economic Literature, American Economic Association, vol. 37(1), pages 7-63, March.
  4. Chwe, Michael Suk-Young, 1990. "Why Were Workers Whipped? Pain in a Principal-Agent Model," Economic Journal, Royal Economic Society, vol. 100(403), pages 1109-21, December.
  5. Josh Lerner & Ulrike Malmendier, 2005. "Contractibility and the Design of Research Agreements," NBER Working Papers 11292, National Bureau of Economic Research, Inc.
  6. William Fuchs, 2005. "Contracting with Repeated Moral Hazard and Private Evaluations," Discussion Papers 04-012, Stanford Institute for Economic Policy Research.
  7. Bolton, Patrick & Scharfstein, David S, 1996. "Optimal Debt Structure and the Number of Creditors," Journal of Political Economy, University of Chicago Press, vol. 104(1), pages 1-25, February.
  8. Sappington, David, 1983. "Limited liability contracts between principal and agent," Journal of Economic Theory, Elsevier, vol. 29(1), pages 1-21, February.
  9. Bentley W. MacLeod, 2003. "Optimal Contracting with Subjective Evaluation," American Economic Review, American Economic Association, vol. 93(1), pages 216-240, March.
  10. Harris, Milton & Raviv, Artur, 1979. "Optimal incentive contracts with imperfect information," Journal of Economic Theory, Elsevier, vol. 20(2), pages 231-259, April.
  11. Schmitz, Patrick W., 2002. "On the Interplay of Hidden Action and Hidden Information in Simple Bilateral Trading Problems," Journal of Economic Theory, Elsevier, vol. 103(2), pages 444-460, April.
  12. Lewis, Tracy R & Sappington, David E M, 1997. "Information Management in Incentive Problems," Journal of Political Economy, University of Chicago Press, vol. 105(4), pages 796-821, August.
  13. Sherstyuk, Katerina, 2000. " Performance Standards and Incentive Pay in Agency Contracts," Scandinavian Journal of Economics, Wiley Blackwell, vol. 102(4), pages 725-36, December.
  14. Roger B. Myerson, 1977. "Incentive Compatability and the Bargaining Problem," Discussion Papers 284, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  15. Baker, George P, 1992. "Incentive Contracts and Performance Measurement," Journal of Political Economy, University of Chicago Press, vol. 100(3), pages 598-614, June.
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