An Experimental Investigation of the ‘Tenuous Trade-off’ between Risk and Incentives in Organizations

Subhasish M. Chowdhury, Alexandros Karakostas

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Abstract

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.
Original languageEnglish
Pages (from-to)1-38
Number of pages38
JournalTheory and Decision
Early online date18 Jun 2019
DOIs
Publication statusPublished - 2019

Keywords

  • Hidden action
  • Incentives
  • Moral hazard
  • Risk

ASJC Scopus subject areas

  • Decision Sciences(all)
  • Developmental and Educational Psychology
  • Arts and Humanities (miscellaneous)
  • Applied Psychology
  • Social Sciences(all)
  • Economics, Econometrics and Finance(all)
  • Computer Science Applications

Cite this

An Experimental Investigation of the ‘Tenuous Trade-off’ between Risk and Incentives in Organizations. / Chowdhury, Subhasish M.; Karakostas, Alexandros.

In: Theory and Decision, 2019, p. 1-38.

Research output: Contribution to journalArticle

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