Rewarding Successes Discourages Experimentation

Kimiko Terai and Amihai Glazer

FinanzArchiv: Public Finance Analysis, 2017, vol. 73, issue 4, 361-381

Abstract: Consider a principal who allocates a fixed budget among risk-averse agents. Each agent first chooses a policy or project. After observing the outcomes of their choices, the principal allocates a larger budget to the agents who had adopted the policy with the superior outcome. A subgame perfect Nash equilibrium may have all agents make the same choice, though the principal would prefer that they experiment. If the number of agents is large, or if the principal commits to reducing the aggregate budget when no agent had the superior outcome, or if he commits to avoid funding a riskless policy, different agents can be induced to adopt different policies.

Keywords: experimentation; risk aversion; budget allocation; innovation; federalism (search for similar items in EconPapers)
JEL-codes: D23 D73 D81 H61 H77 (search for similar items in EconPapers)
Date: 2017
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DOI: 10.1628/001522117X15006332556852

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