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Optimal Incentives in a Principal-Agent Model with Endogenous Technology

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Author Info

  • Marco Marini

    ()
    (Department of Computer, Control and Management Engineering, Università "La Sapienza" Roma)

  • Paolo Polidori

    ()
    (Department of Law, University of Urbino “Carlo Bo”)

  • Davide Ticchi

    ()
    (IMT Institute for Advanced Studies Lucca)

  • Désirée Teobaldelli

    ()
    (Department of Law, University of Urbino “Carlo Bo”)

Abstract

One of the standard predictions of the agency theory is that more incentives can be given to agents with lower risk aversion. In this paper we show that this relationship may be absent or reversed when the technology is endogenous and projects with a higher e¢ ciency are also riskier. Using a modi ed version of the Holmstrom and Milgrom’s (1987) framework, we obtain that lower agent’s risk aversion unambiguously leads to higher incentives when the technology function linking e¢ ciency and riskiness is elastic, while the risk aversion-incentive relation- ship can be positive when this function is rigid.

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File URL: http://www.econ.uniurb.it/RePEc/urb/wpaper/WP_13_04.pdf
File Function: First version, 2013
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Bibliographic Info

Paper provided by University of Urbino Carlo Bo, Department of Economics, Society & Politics - Scientific Committee - L. Stefanini & G. Travaglini in its series Working Papers with number 1304.

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Length: 10 pages
Date of creation: 2013
Date of revision: 2013
Handle: RePEc:urb:wpaper:13_04

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Web page: http://www.econ.uniurb.it/
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Keywords: Principal-agent; Incentives; Risk aversion; Endogenous technolog;

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  1. C. Bram Cadsby & Fei Song & Francis Tapon, 2009. "The Impact of Risk Aversion and Stress on the Incentive Effect of Performance Pay," Working Papers 0912, University of Guelph, Department of Economics and Finance.
  2. Canice Prendergast, 2002. "The Tenuous Trade-off between Risk and Incentives," Journal of Political Economy, University of Chicago Press, vol. 110(5), pages 1071-1102, October.
  3. Patrick Legros & Andrew F. Newman, 2003. "Beauty is a Beast, Frog is a Prince: Assortative Matching with Nontransferabilities," Economics Working Papers 0030, Institute for Advanced Study, School of Social Science.
  4. Wright, Donald J., 2002. "The Risk and Incentives Trade-off in the Presence of Heterogeneous Man agers," Working Papers 2, University of Sydney, School of Economics.
  5. Li, Fei & Ueda, Masako, 2009. "Why do reputable agents work for safer firms?," Finance Research Letters, Elsevier, vol. 6(1), pages 2-12, March.
  6. Konstantinos Serfes, 2008. "Endogenous matching in a market with heterogeneous principals and agents," International Journal of Game Theory, Springer, vol. 36(3), pages 587-619, March.
  7. Bengt Holmstrom & Paul R. Milgrom, 1985. "Aggregation and Linearity in the Provision of Intertemporal Incentives," Cowles Foundation Discussion Papers 742, Cowles Foundation for Research in Economics, Yale University.
  8. Rajesh Aggarwal & Andrew A. Samwick, 1998. "The Other Side of the Tradeoff: The Impact of Risk on Executive Compensation," NBER Working Papers 6634, National Bureau of Economic Research, Inc.
  9. John Core, 2002. "Estimating the Value of Employee Stock Option Portfolios and Their Sensitivities to Price and Volatility," Journal of Accounting Research, Wiley Blackwell, vol. 40(3), pages 613-630, 06.
  10. Grund, Christian & Sliwka, Dirk, 2010. "Evidence on performance pay and risk aversion," Economics Letters, Elsevier, vol. 106(1), pages 8-11, January.
  11. Serfes, Konstantinos, 2005. "Risk sharing vs. incentives: Contract design under two-sided heterogeneity," Economics Letters, Elsevier, vol. 88(3), pages 343-349, September.
  12. Allen, Douglas W & Lueck, Dean, 1995. "Risk Preferences and the Economics of Contracts," American Economic Review, American Economic Association, vol. 85(2), pages 447-51, May.
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