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Irrilevance of profit sharing in the principal-agent model

Author

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  • Susanna Mancinelli
  • Maria Augusta Miceli

Abstract

The aim is to investigate the difference in the functional dependence between incentives based on output and incentives based on an actual share of profit. Although the incentive role of profit sharing in contracts is an established result, we were looking for a functional solution form, able to implement this contract under moral hazard. In order to do this, we added the possibility of profit sharing in the classical principal-agent incentive model. Surprisingly the moral hazard setting lead to negative results both under a ''principal-agent'' and under a ''collusive'' relationship between the two contract parts. The main results may be summarized as follows. (i) Profit and utility function maximization lead to a unique optimal level of both revenues independent of sources: profit sharing has no role independently of contract relationships and, more importantly, independently of relative degrees of risk aversion. (ii) Being revenues the same, the optimal choice for the equilibrium effort level is constant as well. (iii) Collusion under moral hazard has no role, since there is redundancy of either the binding incentive constraint or the collusive role of the agent.

Suggested Citation

  • Susanna Mancinelli & Maria Augusta Miceli, 2001. "Irrilevance of profit sharing in the principal-agent model," Working Papers 46, University of Rome La Sapienza, Department of Public Economics.
  • Handle: RePEc:sap:wpaper:wp46
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    Keywords

    Moral Hazard; Principal-Agent Models; Compensation; Profit sharing.;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • J30 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - General
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods

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