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Revisiting the Tradeoff between Risk and Incentives: The Shocking Effect of Random Shocks

Author

Listed:
  • Brice Corgnet

    () (Chapman University)

  • Roberto Hernán-González

    (University of Nottingham)

Abstract

Despite its central role in the theory of incentives, empirical evidence of a tradeoff between risk and incentives remains scarce. We reexamine this empirical puzzle in a controlled laboratory environment so as to isolate possible confounding factors encountered in the field. In line with the principal-agent model, we find that principals increase fixed pay while lowering performance pay when the relationship between effort and output is noisier. Unexpectedly, agents produce substantially more in the noisy environment than in the baseline despite lesser pay for performance. We show that this result can be accounted for by introducing agents’ loss aversion in the principal-agent model. Our findings call for an extension of standard agency models and for a reassessment of apparently inefficient management practices.

Suggested Citation

  • Brice Corgnet & Roberto Hernán-González, 2015. "Revisiting the Tradeoff between Risk and Incentives: The Shocking Effect of Random Shocks," Working Papers 15-05, Chapman University, Economic Science Institute.
  • Handle: RePEc:chu:wpaper:15-05
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    File URL: http://www.chapman.edu/research-and-institutions/economic-science-institute/_files/WorkingPapers/corgnet_hernan-gonzalez_principal-agent-paper.pdf
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    References listed on IDEAS

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    Cited by:

    1. Corgnet, Brice & Gómez-Miñambres, Joaquín & Hernán-González, Roberto, 2018. "Goal setting in the principal–agent model: Weak incentives for strong performance," Games and Economic Behavior, Elsevier, vol. 109(C), pages 311-326.

    More about this item

    Keywords

    Principal-agent models; incentive theory; loss aversion; laboratory experiments;

    JEL classification:

    • C92 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Group Behavior
    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • M54 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics - - - Labor Management

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