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The Tenuous Trade-off between Risk and Incentives


  • Canice Prendergast


Empirical work testing for a negative trade-off between risk and incentives has not had much success: the data suggest a positive relationship between measures of uncertainty and incentives rather than the posited negative trade-off. I argue that the existing literature fails to account for an important effect of uncertainty on incentives through the allocation of responsibility to employees. When workers operate in certain settings, firms are content to assign tasks to workers and monitor their inputs. By contrast, when the situation is more uncertain, they delegate responsibility to workers but, to constrain their discretion, base compensation on observed output.

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  • 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.
  • Handle: RePEc:ucp:jpolec:v:110:y:2002:i:5:p:1071-1102

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    References listed on IDEAS

    1. Hallagan, William S., 1978. "Share contracting for California Gold," Explorations in Economic History, Elsevier, vol. 15(2), pages 196-210, April.
    2. Rajesh K. Aggarwal & Andrew A. Samwick, 1999. "The Other Side of the Trade-off: The Impact of Risk on Executive Compensation," Journal of Political Economy, University of Chicago Press, vol. 107(1), pages 65-105, February.
    3. Norton, Seth W, 1988. "An Empirical Look at Franchising as an Organizational Form," The Journal of Business, University of Chicago Press, vol. 61(2), pages 197-218, April.
    4. Grossman, Sanford J & Hart, Oliver D, 1983. "An Analysis of the Principal-Agent Problem," Econometrica, Econometric Society, vol. 51(1), pages 7-45, January.
    5. repec:mes:challe:v:30:y:1987:i:4:p:55-56 is not listed on IDEAS
    6. Minkler, Alanson P., 1990. "An empirical analysis of a firm's decision to franchise," Economics Letters, Elsevier, vol. 34(1), pages 77-82, September.
    7. Allen, Douglas & Lueck, Dean, 1992. "Contract Choice in Modern Agriculture: Cash Rent versus Cropshare," Journal of Law and Economics, University of Chicago Press, vol. 35(2), pages 397-426, October.
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