1、Chapter 6 Hidden action problemGeorge HendrikseEconomics and Management of Organisations:Co-ordination,Motivation and Strategy IncentivesBehavioural HypothesisDegree of RationalityCompleteBoundedProceduralOpportunisticHidden actionSelf InterestedUtopianFigure 6.1:Decision order and complete informat
2、ionaabb2/3 1/3R=10R=30R=10R=30e=0e=1ARa,ba,b 11011/32/3PrincipalChoice of contractAgentAcceptance decisionNatureChoice of circumstancesPrincipalPayment to agentAgentEffort decision10-a30-a10-b30-bPayoff principala-0a-0b-1b-1Payoff agentThe principal values a good result(p=30)more than a bad result(p
3、=10),whereas the agent rather delivers a low effort(e=0)than a high effort(e=1).The conflict of interests expresses itself in the fact that an increase in e,which is unattractive for the agent,means that p=30 becomes more likely,which is attractive for the principal.This conflict of interest contras
4、t may result in non acceptance of the contract by the agent,even though executing the transaction would create a surplus.It is also possible that the agent does accept the assignment,but shows bad performance(Moral Hazard).An efficient allocation of risk implies that the principal bears all the unce
5、rtainty,i.e.paying a fixed salary,because the principal is risk-neutral and the agent risk-averse.Efficient performance incentives entail that the agent is stimulated to perform well.This happens in the model above,when the agent is rewarded on the basis of realised outcomes.This goes with uncertain
6、ty for the agent because the result is also determined by external circumstances.Example:Tonsils and open-heart surgeryA surgeon paid per open-heart surgery does twice as many operations than a surgeon with a fixed salary.A surgeon paid per tonsils surgery,does 15 times as many operations than a sur
7、geon with a fixed salary.Figure 6.7:Decision order and asymmetric informationyzyz2/31/3R=10R=30R=10R=30e=0e=1ARy,zy,z 11011/3 2/3PrincipalChoice of contractAgentAcceptance decisionNatureChoice of circumstancesPrincipalPayment to agentAgentEffort decision10-y30-z10-y30-zPayoff principaly-0z-0y-1z-1Pa
8、yoff agentAn uncertain reward(0 with probability 1/3 and 9 with probability 2/3,which costs the principal 1/3*0+2/3*9=6)is valued lower by the agent than a certain reward(6 with chance 1 which costs the principal 6).The uncertain outcome 0 with probability 1/3 and 9 with probability 2/3(which costs
9、the principal 6)is worth 2 for the agent,which is the same as a salary 4 with chance 1,which only costs the principal 4.The principal does not offer a fixed salary 4,4 because the agent would choose e=0 in this situation.The loss of efficiency is caused by the conflict of interests and the risk-aver
10、sion of the agent.It is therefore not possible to establish an efficient allocation of risk as well as efficient performance incentives.(With one variable()you cannot solve two problems.)Determine the payoff maximising contract for the principalTool:Non-cooperative game theorySolution concept:Nash e
11、quilibriumSubgame perfect equilibriumSolution method:Backward inductionIncentive compatibility constraintStructure the contract/payoffs,i.e.choose w(L)and w(H),in such a way that the choice of e=H results in a payoff for the agent which is not less than the payoff associated with the choice of low e
12、ffort e=L.Figure 6.8:Incentive compatibility constraint under asymmetric informationy,ze=0e=1yzyzFirst decisionSecond decisionThird decisionParticipation constraintThe agent accepts an incentive compatible contract when the payoff of the contract for the agent,i.e.w(H)2,is higher than what the agent
13、 can earn elsewhere,i.e.0.Figure 6.9:Participation constraint under asymmetric informationy,zyzyzFirst decisionSecond decisionThird decisionARGC.,.ARLHPrincipalPrincipalContractChoice contract w(9),w(16)AgentAgentAcceptanceChoice effort00009 w(9)w(9)116-w(16)w(16)-2Incentive intensity principlePayof
14、fsPrincipal:P(e)-wAgent:w C(e)Where w=+z z=e+xP(.):Revenue of principalC(.):Costs of efforte:effort w:wagez:outputx:uncertainty:fixed wage:piece rateConflict of interest?Yes,but why?P(e)ww-eIncentive compatibility constraint=C(e)Payoff maximising contract*=P(e)/(1+rVC”(e)Piece rate component is high
15、er when:The agent is less risk averse(r);It is easier to measure the activities of the agent(V);The effort of the agent has more impact on the level of output(P(e);The agent has more discretion regarding the choice of activities(C”(e).Extensions Ratchet effect;Contractual externalities;Generating ad
16、ditional information.Ratchet effectDynamic incentive schemeThe tendency of performance standards to increase after a period of good performance is called the ratchet effect.The ratcheting up of standards in response to good performance is not merely unfair,it can be unproductive.Basing standards on
17、past performance penalises good performance and rewards bad.If workers foresee this possibility,very negative consequences may emerge.There are two themes:Multiple activities;1.Inaccurate performance measurement.Contractual externalitiesWhat does it mean that performance cannot be measured at all?V=
18、Equal compensation principleIf an agent is to allocate effort among different activities,then each must bring the same marginal return to effort.Otherwise,the agent will focus exclusively on the one that yields the greatest impact on his or her income.Examples Teachers Top managers Physical therapis
19、tsPublic policy debateShould teachers be provided with cash incentives to improve education?Yes-it will focus the teachers on their tasks and motivating them to be innovative in the search for effective ways to train their students.No-the measures that have been used in the past to evaluate teaching
20、 performance are tests of basic skills.Teaching basic skills is just one part of a teachers job!Aspects of a teachers job basic skills social skills oral expression creative thinking building confidenceTeachers who are compensated based on tests of basic skills alone may be tempted to neglect these
21、other aspects of the job.Other side effects:Teaching only the most docile students Neglecting students who have trouble learning A teacher was caught teaching the answers to the actual test ConclusionCompensating teachers based on test scores motivates teachers to help students test well,rather than
22、 to help students learn.Two solutionsPay teachers a fixed wage.Remove the responsibility for teaching all these aspects of learning.1.Equal compensation principleIf it is desirable to have teachers devote some effort to each of several activities and if it is impossible to distinguish efforts of the
23、 various activities,then all these kinds of efforts must be compensated equally.If social expression,oral development,or creative thinking can not be accurately measured,then one realistic option is to pay teachers a fixed wage.2.Job design and compensationInstall a system of specialist teachers who
24、 are compensated based on students test scores but who are not responsible for other aspects of student performance.It would allow performance incentives and still ensure that attention is paid to developing the very important higher thinking skills in students.General conclusionBy determining job d
25、esign and compensation together,one can sometimes solve problems that can not be solved by compensation policy alone.Coase:Why are there organizations?An important aspect of the firm is using low-powered incentives!Theme II:Inaccurate performance measurementPerformance measure Incentive system Firm
26、value Employee stock-ownership Firm-wide accounting profits Firm-wide profit sharing Divisional profits Divisional profit-sharing Plant-level profits Plant profit center Plant-level costs Plant cost center Figure 6.15:Possible performance measures and associated incentive systems(Baker,2000,p.419)Generating additional information Tournaments Monitoring
