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Limited Liability and the Risk-Incentive Relationship

  • Budde, Jörg
  • Kräkel, Matthias

Several empirical findings have challenged the traditional view on the trade-off between risk and incentives. By combining risk aversion and limited liability in a standard principal-agent model the empirical puzzle on the positive relationship between risk and incentives can be explained. Increasing risk leads to a less informative performance signal. Under limited liability, the principal may optimally react by increasing the weight on the signal and, hence, choosing higher-powered incentives.

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File URL: http://epub.ub.uni-muenchen.de/13320/1/232.pdf
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Paper provided by Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich in its series Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems with number 232.

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Date of creation: Mar 2008
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Handle: RePEc:trf:wpaper:232
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