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Subjective evaluation versus public information

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Author Info

  • 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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Bibliographic Info

Paper provided by Free University Berlin, School of Business & Economics in its series Discussion Papers with number 2013/6.

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Date of creation: 2013
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Handle: RePEc:zbw:fubsbe:20136

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

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References

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  1. Josh Lerner & Ulrike Malmendier, 2005. "Contractibility and the Design of Research Agreements," NBER Working Papers 11292, National Bureau of Economic Research, Inc.
  2. Canice Prendergast, 1999. "The Provision of Incentives in Firms," Journal of Economic Literature, American Economic Association, vol. 37(1), pages 7-63, March.
  3. William Fuchs, 2007. "Contracting with Repeated Moral Hazard and Private Evaluations," American Economic Review, American Economic Association, vol. 97(4), pages 1432-1448, September.
  4. Bentley W. MacLeod, 2003. "Optimal Contracting with Subjective Evaluation," American Economic Review, American Economic Association, vol. 93(1), pages 216-240, March.
  5. Matthias Lang, 2012. "Communicating Subjective Evaluations," Working Paper Series of the Max Planck Institute for Research on Collective Goods 2012_14, Max Planck Institute for Research on Collective Goods, revised Mar 2014.
  6. 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.
  7. Baker, George P, 1992. "Incentive Contracts and Performance Measurement," Journal of Political Economy, University of Chicago Press, vol. 100(3), pages 598-614, June.
  8. Harris, Milton & Raviv, Artur, 1979. "Optimal incentive contracts with imperfect information," Journal of Economic Theory, Elsevier, vol. 20(2), pages 231-259, April.
  9. 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.
  10. Myerson, Roger B, 1979. "Incentive Compatibility and the Bargaining Problem," Econometrica, Econometric Society, vol. 47(1), pages 61-73, January.
  11. 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.
  12. Sappington, David, 1983. "Limited liability contracts between principal and agent," Journal of Economic Theory, Elsevier, vol. 29(1), pages 1-21, February.
  13. Schmitz, Patrick W., 2002. "On the Interplay of Hidden Action and Hidden Information in Simple Bilateral Trading Problems," MPRA Paper 12531, University Library of Munich, Germany.
  14. Sherstyuk, Katerina, 2000. " Performance Standards and Incentive Pay in Agency Contracts," Scandinavian Journal of Economics, Wiley Blackwell, vol. 102(4), pages 725-36, December.
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