Sharp and Diffuse Incentives in Contracting
This paper investigates the optimality of sharp incentives in contracts where output prices are set at the time of contracting but are random in nature. It shows that when prices are specified with error, schemes involving sharp incentives might result in substantial deviations from first-best output levels. The randomness of prices creates arbitrage opportunities that are exploited by agents producing phenomena such as "cost-shifting". Both linear and piece-wise linear contracts are shown to be subject to the possibility of arbitrage. The paper then demonstrates that incentive schemes that are arbitrage-proof exhibit "diffuse" incentives.
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- Pascal Courty & Gerald Marschke, 2004.
"An Empirical Investigation of Gaming Responses to Explicit Performance Incentives,"
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- Simon Burgess & Marisa Ratto, 2003. "The Role of Incentives in the Public Sector: Issues and Evidence," The Centre for Market and Public Organisation 03/071, Department of Economics, University of Bristol, UK.
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