Principal–Agent Settings with Random Shocks

Jared Rubin and Roman Sheremeta

Management Science, 2016, vol. 62, issue 4, 985-999

Abstract: Using a gift-exchange experiment, we show that the ability of reciprocity to overcome incentive problems inherent in principal–agent settings is greatly reduced when the agent’s effort is distorted by random shocks and transmitted imperfectly to the principal. Specifically, we find that gift exchange contracts without shocks encourage effort and wages well above standard predictions. However, the introduction of random shocks reduces wages and effort, regardless of whether the shocks can be observed by the principal. Moreover, the introduction of shocks significantly reduces the probability of fulfilling the contract by the agent, the payoff of the principal, and total welfare. Therefore, our findings demonstrate that random shocks place an important bound on the ability of gift exchange to overcome principal–agent problems.Data, as supplemental material, are available at http://dx.doi.org/10.1287/mnsc.2015.2177 . This paper was accepted by John List, behavioral economics.

Keywords: gift exchange; principal–agent model; contract theory; reciprocity; effort; shocks; laboratory experiment (search for similar items in EconPapers)
Date: 2016
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Citations: View citations in EconPapers (31)

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http://dx.doi.org/10.1287/mnsc.2015.2177 (application/pdf)

Related works:
Working Paper: Principal-Agent Settings with Random Shocks (2015)
Working Paper: Principal-Agent Settings with Random Shocks (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:62:y:2016:i:4:p:985-999

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