lecture_6_tab - Incentive compensation The basic problem -...

Info iconThis preview shows pages 1–5. Sign up to view the full content.

View Full Document Right Arrow Icon
ECOS3003 Lecture 6 1 Incentive compensation The basic problem - owners and employees have different objectives - need to motivate employees to work in the interest of the firm If effort is observable and can be contracted on - compensation package can say “pay you $X if you put in effort level e*” - could induce more effort, but beyond MB=MC profits fall
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
ECOS3003 Lecture 6 2 What if action/effort is not observable? - agent promises e*, but reneges to do less or nothing Points (1) incentive problems exist because of conflict of interests (employers/employees) - if align interests, no problems (2) incentive problems do not occur if actions observable and contractible (3) in market, employees need to be compensated for effort
Background image of page 2
ECOS3003 Lecture 6 3 Ownership as an incentive device - what about ‘selling’ the firm/operation to the employee? - employee becomes the residual claimant - ownership provides incentive to put in desired effort (also franchising, providing incentive to max surplus) Why not always used? - wealth constraints - risk aversion; as output is random to some extent, selling the firm means employee bears the full risk. Most employees risk averse; risk aversion limits scope to sell firm completely to employees - team production (free rider problems)
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
ECOS3003 Lecture 6 4 Optimal risk sharing - trading opportunity; reduce risk faced by risk averse agent Principle : surplus increased when risk is borne by the risk-neutral party (not the risk-averse party) Effective incentive contracts Two complications: (1) motivating employees (2) share risks more efficiently - there is a trade off between providing incentives and risk sharing
Background image of page 4
Image of page 5
This is the end of the preview. Sign up to access the rest of the document.

Page1 / 16

lecture_6_tab - Incentive compensation The basic problem -...

This preview shows document pages 1 - 5. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online