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Principal-Agent Settings with Random Shocks

Author

Listed:
  • Jared Rubin

    (Argyros School of Business and Economics, Chapman University)

  • Roman Sheremeta

    () (Argyros School of Business and Economics, Chapman University)

Abstract

Using a gift exchange experiment, we show that the ability of reciprocity to overcome incentive problems inherent in principal-agent settings is greatly reduced when the agent’s effort is distorted by random shocks and transmitted imperfectly to the principal. Specifically, we find that gift exchange contracts without shocks encourage effort and wages well above standard predictions. However, the introduction of random shocks reduces wages and effort, regardless of whether the shocks can be observed by the principal. Moreover, the introduction of shocks significantly reduces the probability of fulfilling the contract by the agent, the payoff of the principal, as well as total welfare.

Suggested Citation

  • Jared Rubin & Roman Sheremeta, 2012. "Principal-Agent Settings with Random Shocks," Working Papers 12-21, Chapman University, Economic Science Institute.
  • Handle: RePEc:chu:wpaper:12-21
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Giuseppe Danese & Luigi Mittone, 2015. "Trust and trustworthiness in experimental organizations," CEEL Working Papers 1501, Cognitive and Experimental Economics Laboratory, Department of Economics, University of Trento, Italia.
    2. Kimbrough, Erik & Laughren, Kevin & Sheremeta, Roman, 2017. "War and Conflict in Economics: Theories, Applications, and Recent Trends," MPRA Paper 80277, University Library of Munich, Germany.
    3. Drew Fudenberg, 2015. "Tirole's Industrial Regulation and Organization Legacy in Economics," Scandinavian Journal of Economics, Wiley Blackwell, vol. 117(3), pages 771-800, July.
    4. Rand, David G. & Fudenberg, Drew & Dreber, Anna, 2015. "It's the thought that counts: The role of intentions in noisy repeated games," Journal of Economic Behavior & Organization, Elsevier, pages 481-499.
    5. Roman M. Sheremeta, 2016. "The pros and cons of workplace tournaments," IZA World of Labor, Institute for the Study of Labor (IZA), pages 302-302.
    6. Pedro Rey-Biel & Roman Sheremeta & Neslihan Uler, 2015. "When Income Depends on Performance and Luck: The Effects of Culture and Information on Giving," Working Papers 15-12, Chapman University, Economic Science Institute.
    7. Roman M. Sheremeta, 2016. "The Pros and Cons of Workplace Tournaments," Working Papers 16-27, Chapman University, Economic Science Institute.
    8. Roman M. Sheremeta, 2016. "The pros and cons of workplace tournaments," IZA World of Labor, Institute for the Study of Labor (IZA), pages 302-302.
    9. repec:spr:jesaex:v:3:y:2017:i:2:d:10.1007_s40881-017-0041-2 is not listed on IDEAS
    10. Dan Kovenock & Brian Roberson & Roman M. Sheremeta, 2010. "The Attack and Defense of Weakest-Link Networks," Working Papers 10-14, Chapman University, Economic Science Institute.
    11. Gerhards, Leonie & Heinz, Matthias, 2017. "In good times and bad – Reciprocal behavior at the workplace in times of economic crises," Journal of Economic Behavior & Organization, Elsevier, pages 228-239.
    12. repec:eee:joepsy:v:62:y:2017:i:c:p:87-97 is not listed on IDEAS

    More about this item

    Keywords

    gift exchange; principal-agent model; contract theory; reciprocity; effort; shocks; laboratory experiment;

    JEL classification:

    • C72 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Noncooperative Games
    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
    • D63 - Microeconomics - - Welfare Economics - - - Equity, Justice, Inequality, and Other Normative Criteria and Measurement
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • H50 - Public Economics - - National Government Expenditures and Related Policies - - - General

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