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Specific Knowledge and Performance Measurement

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  • Raith, Michael

Abstract

This Paper examines optimal incentives and performance measurement in a setting where an agent has specific knowledge about the consequences of their actions for the principal. I study incentive contracts in which the agent’s compensation can be based on both ‘input’ measures closely related to the agent’s actions, and ‘output’ measures closely related to the principal’s pay-off. I argue that when the agent has specific knowledge (i.e. private information that is difficult to communicate) about how their actions contribute to the principal’s pay-off, output-based pay encourages the agent to use their knowledge while input-based pay does not. I show within a two-task agency model that (partially) output-based compensation is optimal even when the agent’s actions on each task can be measured perfectly. Comparative statics results show how the optimal choice of performance measures and incentives depends on the agent’s knowledge, environmental risk, technological uncertainty, and job complexity. The theory leads to several novel predictions, as well as new explanations for existing empirical findings.

Suggested Citation

  • Raith, Michael, 2004. "Specific Knowledge and Performance Measurement," CEPR Discussion Papers 4262, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:4262
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    1. repec:bla:jemstr:v:26:y:2017:i:1:p:231-256 is not listed on IDEAS
    2. Gottardi, Piero & Tallon, Jean Marc & Ghirardato, Paolo, 2017. "Flexible contracts," Games and Economic Behavior, Elsevier, vol. 103(C), pages 145-167.
    3. Chang, Ya-Kai & Chen, Yu-Lun & Chou, Robin K. & Huang, Tai-Hsin, 2015. "Corporate governance, product market competition and dynamic capital structure," International Review of Economics & Finance, Elsevier, vol. 38(C), pages 44-55.
    4. Jed Devaro & Fidan Ana Kurtulus, 2010. "An Empirical Analysis of Risk, Incentives and the Delegation of Worker Authority," ILR Review, Cornell University, ILR School, vol. 63(4), pages 641-661, July.
    5. Nannerup, Niels & Olsen, Kasper Krogh, 2014. "Multitasking and performance measurement," Discussion Papers of Business and Economics 20/2014, University of Southern Denmark, Department of Business and Economics.
    6. Anthony M. Marino & Ján Zábojník, 2008. "Work-related perks, agency problems, and optimal incentive contracts," RAND Journal of Economics, RAND Corporation, vol. 39(2), pages 565-585.
    7. Ben-Ner, Avner & Kong, Fanmin & Lluis, Stéphanie, 2012. "Uncertainty, task environment, and organization design: An empirical investigation," Journal of Economic Behavior & Organization, Elsevier, vol. 82(1), pages 281-313.
    8. Maria De Paola & Vincenzo Scoppa, 2010. "Effort Observability, Incentive Systems, and Organizational Forms," LABOUR, CEIS, vol. 24(3), pages 221-237, September.
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    11. Alonso-Paulí, Eduard & André, Francisco J., 2015. "Standardized environmental management systems as an internal management tool," Resource and Energy Economics, Elsevier, vol. 40(C), pages 85-106.
    12. Ana-Maria Godeanu, 2012. "The antecedents of satisfaction with pay in teams: do performance-based compensation and autonomy keep team-members satisfied?," Eastern Journal of European Studies, Centre for European Studies, Alexandru Ioan Cuza University, vol. 3, pages 145-168, June.
    13. repec:kap:sbusec:v:50:y:2018:i:1:d:10.1007_s11187-017-9885-3 is not listed on IDEAS
    14. Chen, Bo, 2012. "All-or-nothing payments," Journal of Mathematical Economics, Elsevier, vol. 48(3), pages 133-142.
    15. Jed De Varo & Suraj Prasad, 2015. "The Relationship between Delegation and Incentives Across Occupations: Evidence and Theory," Journal of Industrial Economics, Wiley Blackwell, vol. 63(2), pages 279-312, June.
    16. Alberto Bayo-Moriones & Jose E. Galdon-Sanchez & Sara Martinez-de-Morentin, 2017. "Performance Measurement and Incentive Intensity," Journal of Labor Research, Springer, vol. 38(4), pages 496-546, December.
    17. Piero Gottardi & Jean-Marc Tallon & Paolo Ghirardato, 2015. "Flexible contracts," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) hal-01238046, HAL.
    18. Engert, Andreas & Goldlücke, Susanne, 2013. "Why agents need discretion: The business judgment rule as optimal standard of care," Working Papers 13-04, University of Mannheim, Department of Economics.
    19. Fich, Eliezer M. & Starks, Laura T. & Yore, Adam S., 2014. "CEO deal-making activities and compensation," Journal of Financial Economics, Elsevier, vol. 114(3), pages 471-492.
    20. Shi, Lan, 2011. "Respondable risk and incentives for CEOs: The role of information-collection and decision-making," Journal of Corporate Finance, Elsevier, vol. 17(1), pages 189-205, February.
    21. Antti Kauhanen & Sami Napari, 2012. "Performance Measurement and Incentive Plans," Industrial Relations: A Journal of Economy and Society, Wiley Blackwell, vol. 51(3), pages 645-669, July.
    22. DeVaro, Jed, 2011. "Using "opposing responses" and relative performance to distinguish empirically among alternative models of promotions," MPRA Paper 35175, University Library of Munich, Germany.
    23. repec:bla:abacus:v:52:y:2016:i:4:p:685-771 is not listed on IDEAS

    More about this item

    Keywords

    distortion; incentives; input- vs output-based pay; M52; multitask agency model; performance measurement; risk; specific knowledge;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods

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