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Against the Odds! The Tradeoff Between Risk and Incentives is Alive and Well

Brice Corgnet, Roberto Hernan-Gonzalez (), Yao Kpegli and Adam Zylbersztejn ()
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Roberto Hernan-Gonzalez: Burgundy School of Business, Dijon, France
Adam Zylbersztejn: Univ Lyon, Université Lyon 2, GATE UMR 5824, F-69130 Ecully, France; research fellow at Vistula University Warsaw (AFiBV), Warsaw, Poland

Authors registered in the RePEc Author Service: Roberto Hernán González

No 2305, Working Papers from Groupe d'Analyse et de Théorie Economique Lyon St-Étienne (GATE Lyon St-Étienne), Université de Lyon

Abstract: The risk-incentives tradeoff (RIT) is a fundamental result of principal-agent theory. Yet, empirical evidence has been elusive. This could be due to a lack of robustness of the theory outside of the standard expected utility framework (EUT) or to confounding factors in the empirical tests. First, we theoretically study the existence of RIT under alternative theories: Rank-Dependent Utility (RDU) and Mean-Variance-Skewness (MVS). We show that RIT is remarkably robust under RDU, but not under MVS. Second, we use a novel experimental design that eliminates confounding factors and find evidence for RIT even in the case of risk-seeking agents, which is a distinct prediction of RDU. Our results provide support for the risk-incentives tradeoff and suggest that it applies to a broad range of situations including cases in which agents are risk-seeking (e.g., executive compensation).

Keywords: Risk-Incentives Tradeoff; Rank-Dependent Utility; Mean-Variance-Skewness; Experiments (search for similar items in EconPapers)
JEL-codes: C92 D23 D86 M54 (search for similar items in EconPapers)
Date: 2023
New Economics Papers: this item is included in nep-exp, nep-hrm, nep-rmg and nep-upt
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