Binary Payment Schemes: Moral Hazard and Loss Aversion

Fabian Herweg (), Daniel Müller () and Philipp Weinschenk ()
Additional contact information
Daniel Müller: University of Bonn
Philipp Weinschenk: Max Planck Institute for Research on Collective Goods

No 2010_38, Discussion Paper Series of the Max Planck Institute for Research on Collective Goods from Max Planck Institute for Research on Collective Goods

Abstract: We modify the principal-agent model with moral hazard by assuming that the agent is expectation-based loss averse according to Köszegi and Rabin (2006, 2007). The optimal contract is a binary payment scheme even for a rich performance measure, where standard preferences predict a fully contingent contract. The logic is that, due to the stochastic reference point, increasing the number of different wages reduces the agent’s expected utility without providing strong additional incentives. Moreover, for diminutive occurrence probabilities for all signals the agent is rewarded with the fixed bonus if his performance exceeds a certain threshold.

JEL-codes: D82 M12 M52 (search for similar items in EconPapers)
Date: 2010-09
New Economics Papers: this item is included in nep-cta and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (154)

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Related works:
Journal Article: Binary Payment Schemes: Moral Hazard and Loss Aversion (2010)
Working Paper: Binary payment schemes: Moral hazard and loss aversion (2010)
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Persistent link: https://EconPapers.repec.org/RePEc:mpg:wpaper:2010_38

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