incentives1-16-17 - Session#16/17 Outline Signaling(2...

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Session #16/17 Outline: Signaling (2 minutes) Explicit Incentives: Intro The principal-agent model The optimal compensation contract (risk neutral agent)
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Signaling. Recap. Main ideas: For a signal to be credible : It has to be costly for the party “emitting” the signal The cost of the signal has to be lower for the party that wants to signal his/her characteristics Ex.: how long can you remain under water? If the signal does not by itself increase value b it will be inefficient Possibility of signaling can be harmful even for those who could potentially gain from signaling A signal, however, can be efficient if: It improves productivity (human capital) It allows for better assignment of candidates to tasks
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We’re going to examine the ways in which the means and manner of executive compensation have contributed to a reckless culture and quarter-by-quarter mentality that in turn have rought havoc in our financial system. We’re wrought havoc in our financial system. We’re going to be taking a look at broader reforms so that executives are compensated for sound risk management and rewarded for growth measured over years, not just days or weeks .” B. Obama, US President, Feb. 2009
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Incentives matter! Compensation contracts matter!
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Life insurance contracts: If the insured commits suicide, company pays the beneficiary only if suicide occurs after certain time has passed since insurance policy issued (12 or 24 months) Rationale: adverse selection Statistics show that for those covered by life insurance, suicide rate is lowest for months 12 and 24 highest for months 13 and 25 b monetary incentives matter for those about to commit suicide!
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Monetary incentives matter!
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Session #16 Outline: Signaling (2 minutes) Explicit Incentives: Intro The principal-agent model The optimal compensation contract (risk neutral agent)
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2. Internal Organization: Selection and Incentives 2.1. Selection: signaling and screening 2.2 Explicit incentives
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Explicit incentives Organizations composed of individuals Individuals have their own goals, may not coincide with those of the organization Very often, not possible to observe what mployees do employees do b to ensure that individuals contribute to organization’s goal, they must have the incentives to do so
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Explicit incentives Sources of incentives: Ethical : individuals may consider it an ethical duty to carry out their assigned tasks in the best possible way Enjoyment : employees may like carrying out eir tasks their tasks Reciprocity ,... We will focus on a particular source of investments: ( direct or indirect ) monetary incentives To study these incentives we will use the “principal-agent model”
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The Principal-Agent Model Relationship between organization and member/employee can be represented by Principal-Agent Model ”: rincipal ires the gent carry out a task Principal hires the agent to carry out a task How the task is carried out (the actions taken by the agent) determines the value generated by it. The principal
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incentives1-16-17 - Session#16/17 Outline Signaling(2...

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