Limited liability and the risk–incentive relationship

Budde, Jörg; Kräkel, Matthias

doi:10.1007/s00712-010-0183-7

Cited by 7 publications

(5 citation statements)

References 31 publications

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“…This also confirms the argument that the empirical studies, which found a positive or no relationship, may have been due to the variety of other confounding factors. Consequently, our findings provide support to theorists who introduced alternative dimensions or additional variables to explain the observed positive relationship in the previous studies (e.g., Prendergast 2002;Wright 2004;Budde and Kräkel 2011).…”

Section: Discussionsupporting

confidence: 86%

“…For instance, Prendergast (2002) argues that the delegation of principal's authority to an agent can explain the evidence for a positive relationship between incentive intensity and performance measure. Similarly, Budde and Kräkel (2011) show that combining risk aversion to limited liability could account for such a positive relationship. Likewise, Wright (2004) demonstrates that when one accounts for heterogeneous managers differing in their degrees of risk aversion, both negative and positive relationships are plausible.…”

Section: Introductionmentioning

confidence: 90%

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An experimental investigation of the ‘tenuous trade-off’ between risk and incentives in organizations

Chowdhury

Karakostas

2019

Theory Decis

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We investigate experimentally the relationship between risk and incentives in a principal-agent setting. In contrast to the existing empirical literature that describes such relationship as 'tenuous' or inconclusive, we find a clear negative relationship-supporting the prediction of the standard theoretical model. Specifically, we find that principals reduce the size of the offered piece rates with an increase in risk and instead provide positive fixed wages. Furthermore, we find no relationship between the variance in the performance and the effort choice of the agent, and a strong positive relationship between the effort choice of the agents and the offered piece rates as well as fixed wage, suggesting positive reciprocity. Finally, we find evidence of social projection by the principals regarding the agents' degree of risk aversion.

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Section: Discussionsupporting

confidence: 86%

Section: Introductionmentioning

confidence: 90%

An experimental investigation of the ‘tenuous trade-off’ between risk and incentives in organizations

Chowdhury

Karakostas

2019

Theory Decis

View full text Add to dashboard Cite

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“…Because a level with a higher likelihood ratio is more informative about the event that the agent works ( = 1), this introduces the possibility of rewarding the agent for less informative output levels when a pay cap binds the rewards for more informative output levels. Our result will not hold if there is only one output level with positive likelihood ratio, such as in the binary-output models of Demougin and Gravie [7], Demougin and Fluet [8] or Budde and Kräkel [4] because a binding pay cap will simply makes it impossible to implement  = 1, and hence different binding pay caps do not make any difference.…”

Section: The Model Setupmentioning

confidence: 91%

Can Agents Be Better Off with Pay Caps?

Chou

Chen

2015

Scandinavian J Economics

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Imposing caps on managers' pay has been a popular way to discipline managers of companies or banks that got into trouble during the recent financial crisis. Using a small extension of the standard principal-agent model, we argue that pay caps may serve the opposite purpose because the agent can be better off with a pay cap. Specifically, we show that, given a fixed effort level to be implemented, the agent's expected utility can be decreasing in an upper bound for the agent's reward. The model also offers a characterization of the effect of pay caps on the general structure of optimal incentive contracts.While improvement of contracting information always helps the principal, it may increase or decrease the marginal cost of imposing pay caps.

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“…Typically, observed output does not depend on effort alone but also on risky factors that are beyond the control of the agent. As risk averse agents demand a compensation for exposure to risk, principals optimally offer them a lower piece rate and a higher base payment to reduce risk exposure, given unlimited liability ( Budde and Kräkel, 2011 ). Since the risk premium that risk averse agents demand rises as output risk increases, the optimal piece rate is lower the higher output risk is.…”

Section: Introductionmentioning

confidence: 99%