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Principal-Agent Settings with Random Shocks

  • Jared Rubin

    (Argyros School of Business and Economics, Chapman University)

  • Roman Sheremeta

    ()

    (Argyros School of Business and Economics, Chapman University)

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.

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File URL: http://www.chapman.edu/research-and-institutions/economic-science-institute/_files/WorkingPapers/rubin-sheremeta-principle-agent-setting-with-random-shocks.pdf
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Paper provided by Chapman University, Economic Science Institute in its series Working Papers with number 12-21.

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Length: 40 pages
Date of creation: 2012
Date of revision:
Handle: RePEc:chu:wpaper:12-21
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