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Revisiting the Trade-off Between Risk and Incentives: The Shocking Effect of Random Shocks?

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  • Brice Corgnet

    (EM Lyon Business School, GATE L-SE, Lyon, 69130 Écully, France)

  • Roberto Hernán-González

    (Université Bourgogne Franche-Comté, Burgundy School of Business–CEREN (EA 7477), 21000 Dijon, France)

Abstract

Despite its central role in the theory of incentives, empirical evidence of a trade-off between risk and incentives remains scarce. We reexamine this trade-off in a workplace lab environment and find that, in line with theory, principals increase fixed pay while lowering performance pay when the relationship between effort and output is noisier. Unexpectedly, agents produce substantially more in the noisy environment than in the baseline despite weaker incentives. In addition, principals’ earnings are significantly higher in the noisy environment. We show that these findings can be accounted for when agents maximize a non-CARA utility function or when they exhibit loss aversion.

Suggested Citation

  • Brice Corgnet & Roberto Hernán-González, 2019. "Revisiting the Trade-off Between Risk and Incentives: The Shocking Effect of Random Shocks?," Management Science, INFORMS, vol. 65(3), pages 1096-1114, March.
  • Handle: RePEc:inm:ormnsc:v:65:y:2019:i:3:p:1096-1114
    DOI: 10.1287/mnsc.2017.2914
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    More about this item

    Keywords

    principal–agent models; incentive theory; loss aversion; laboratory experiments;
    All these keywords.

    JEL classification:

    • C92 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Group Behavior
    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • M54 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics - - - Labor Management

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