Sharp and Diffuse Incentives in Contracting

Flavio Menezes and John Quiggin

No 151183, Risk and Sustainable Management Group Working Papers from University of Queensland, School of Economics

Abstract: This paper investigates the optimality of sharp incentives in contracts where output prices are set at the time of contracting but are random in nature. It shows that when prices are specified with error, schemes involving sharp incentives might result in substantial deviations from first-best output levels. The randomness of prices creates arbitrage opportunities that are exploited by agents producing phenomena such as "cost-shifting". Both linear and piece-wise linear contracts are shown to be subject to the possibility of arbitrage. The paper then demonstrates that incentive schemes that are arbitrage-proof exhibit "diffuse" incentives.

Keywords: Risk; and; Uncertainty (search for similar items in EconPapers)
Pages: 16
Date: 2007
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://ageconsearch.umn.edu/record/151183/files/WPR07_06.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:ags:uqsers:151183

DOI: 10.22004/ag.econ.151183

Access Statistics for this paper

More papers in Risk and Sustainable Management Group Working Papers from University of Queensland, School of Economics Contact information at EDIRC.
Bibliographic data for series maintained by AgEcon Search ().