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Solomonic separation: Risk decisions as productivity indicators

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  • Nolan Miller
  • Alexander Wagner
  • Richard Zeckhauser

Abstract

A principal provides budgets to agents (e.g., divisions of a firm or the principal’s children) whose expenditures provide her benefits, either materially or because of altruism. Only agents know their potential to generate benefits. We prove that if the more “productive” agents are also more risk-tolerant (as holds in the sample of individuals we surveyed), the principal can screen agents and bolster target efficiency by offering a choice between a nonrandom budget and a two-outcome risky budget. When, at very low allocations, the ratio of the more risk-averse type’s marginal utility to that of the other type is unbounded above (e.g., as with CRRA), the first-best is approached.—A biblical opening enlivens the analysis. Copyright Springer Science+Business Media New York 2013

Suggested Citation

  • Nolan Miller & Alexander Wagner & Richard Zeckhauser, 2013. "Solomonic separation: Risk decisions as productivity indicators," Journal of Risk and Uncertainty, Springer, vol. 46(3), pages 265-297, June.
    • Handle: RePEc:kap:jrisku:v:46:y:2013:i:3:p:265-297
    DOI: 10.1007/s11166-013-9168-6
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    2. Gibson Brandon, Rajna & Wagner, Alexander F. & Tanner, Carmen, 2014. "How effective are social norm interventions? Evidence from a laboratory experiment on managerial honesty," CEPR Discussion Papers 9880, C.E.P.R. Discussion Papers.

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    More about this item

    Keywords

    Asymmetric information; Capital budgeting; Random mechanisms; Risk aversion; Screening; Target efficiency; D82; G31;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • H12 - Public Economics - - Structure and Scope of Government - - - Crisis Management

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