ADEclass19_70_20_71_forstudents

ADEclass19_70_20_71_forstudents - Outline: Outline:...

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utline: Outline: Explicit Incentives: omplementarity onitoring centives Complementarity monitoring-incentives Optimal selection of performance measures
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Optimal incentives for a risk-averse agent. Recap. Risk neutral principal & risk averse agent: From the point of view of allocation of risk: optimal to make p=0 From the point of view of incentives (if risk were not an issue): optimal to make p=1 trade-off insurance-incentives. Optimal trade-off depends on: Cost of risk for the agent Amount of risk (variance of the performance measure) Degree of risk aversion Cost of effort : how rapidly the marginal cost of ffort creases ith ffort effort increases with effort
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Optimal incentives for a risk-averse agent. Recap. ot ptimal et =1 1 . Not optimal to set p1 . 2. Incentive Intensity Principle (IIP) . Incentive Intensity Principle Incentives will be stronger ( p larger): The lower thevariance of the performance measure ( z ) (the lower the risk). he ss verse e gent e wer The less averse the agent (the lower r ). The more slowly the marginal cost of effort of the gent creases agent increases.
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Optimal incentives for a risk-averse agent 3 . Complementarity monitoring-incentives. IIP: the lower the variance of the measure of effort (in our case, Var(z) = σ 2 ) less costly to provide incentives the higher the optimal p Implication: Suppose we can invest in a technology that gives us a measure of the agent’s effort that is more recise (lower variance ) than precise (lower variance ) than z The more precise our measure of effort (the lower e variance) P e higher the optimal the variance) IIP the higher the optimal p monitoring and explicit incentives are complementary py
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Optimal incentives for a risk-averse agent hat do you think about this statement? What do you think about this statement? “A substantial fraction of our employees' pay is ow tied to performance I think that we should now tied to performance. I think that we should thus reduce monitoring costs. Employees lready have the necessary motivation ” already have the necessary motivation.
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Optimal selection of performance measures yllabus: Syllabus: 2.2.3 Multi-tasking and optimal compensation 2.2.4 The choice of performance measures We merge them: 2.2.3-2.2.4 Optimal selection of performance measures
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Optimal selection of performance measures o far our problem was: So far our problem was: We have a performance measure ( z ) How strongly do we make the A's pay depend on our performance measure? IIP In real life, however, there are often different potential performance measures.
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Optimal selection of performance measures Manager of a large company: different accounting gg p y g measures, stock-based measures, absolute / relative performance measures, . .. Divisional manager: firm-level vs division level accounting measures, absolute / relative performance, “qualitative” performance appraisals.
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ADEclass19_70_20_71_forstudents - Outline: Outline:...

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