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Common Shocks and Relative Compensation Schemes

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  • Michael Magill
  • Martine Quinzii

Abstract

This paper studies qualitative properties of an optimal contract in a multi-agent setting in which agents are subject to a common shock. We derive a necessary and sufficient condition for the optimal reward of an agent producing an output level y to be a decreasing (increasing) function of the outputs of the other agents, under the assumption that the agents’ outputs are informative signals of the value of the common shock. The condition is that the likelihood ratio p(y, e, u)/p(y, e', u), where e is a higher effort level than e', and u is the value of the common shock, be a decreasing (increasing) function of u. We derive conditions on the way the common shock affects the marginal product of effort under which the likelihood ratio is decreasing for all output levels, or increasing for some output levels and decreasing for others.

Suggested Citation

  • Michael Magill & Martine Quinzii, 2004. "Common Shocks and Relative Compensation Schemes," IEPR Working Papers 05.21, Institute of Economic Policy Research (IEPR).
    • Handle: RePEc:scp:wpaper:05-21
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    References listed on IDEAS

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    1. Rogerson, William P, 1985. "The First-Order Approach to Principal-Agent Problems," Econometrica, Econometric Society, vol. 53(6), pages 1357-1367, November.
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    Cited by:

    1. Michael Magill & Martine Quinzii, 2005. "An Equilibrium Model of Managerial Compensation," IEPR Working Papers 05.22, Institute of Economic Policy Research (IEPR).

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    More about this item

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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