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Web End = J Econ (2016) 118:7789
DOI 10.1007/s00712-015-0454-4
Received: 7 August 2014 / Accepted: 12 August 2015 / Published online: 3 September 2015 Springer-Verlag Wien 2015
Abstract Standard principalagent models study the situation in which there is moral hazard within a given production method. The classic prediction of these models is that incentives tend to decrease with risk and risk averseness of the agent. The prediction is inconsistent with empirical ndings, which reveal that both negative and positive relationships between risk and the power of incentives co-exist in the real-world. Our paper develops a tractable model to illustrate that introducing innovation effort could well explain the puzzle of the relationships between the power of incentives, risk and risk-averseness of the agent. In particular, we assume that the agent can exert two unobservable efforts: a production effort and an innovation effort. While the production effort can increase output within a particular production method, the innovation effort can generate an innovative but riskier production method. We show that, when inducing innovation is unnecessary, the standard result that incentives tend to decrease with risk and risk averseness holds. However, when inducing innovation
B Sanxi Li
Pu Chen [email protected]
Jianye Yan [email protected]
Xundong Yin [email protected]
1 School of Economics, Renmin University of China, Beijing, China
2 Research Center for Games and Economic Behavior, Shandong University, Jinan, China
3 School of Banking and Finance, University of International Business and Economics, Beijing,
China4 CAPFPP, Central University of Finance and Economics, Beijing, China
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Web End = Moral hazard in innovation: the relationship between risk aversion and performance pay
Pu Chen1 Sanxi Li1 Jianye Yan2,3
Xundong Yin4
123
78 P. Chen et al.
becomes necessary, incentives may increase with risk and risk averseness. The insights in this paper are especially important today, when innovative but riskier technologies upgrade very quickly.
Keywords Risk aversion The power of incentive The production effort The
innovation effort
JEL Classication D80 J33
1 Introduction
Standard principalagent models (e.g., Holmstrom and Milgrom 1987) predict both a negative relationship between risk and performance pay and a negative relationship...