Loss Aversion, Stochastic Compensation, and Team Incentives

Kohei Daido and Takeshi Murooka

No 107, Discussion Paper Series from School of Economics, Kwansei Gakuin University

Abstract: We investigate moral-hazard problems with limited liability where agents have expectation-based reference-dependent preferences. We show that stochastic compensation for low performance can be optimal. Because of loss aversion, the agents have first-order risk aversion to wage uncertainty. This causes the agents to work harder when their low performance is stochastically compensated. We also examine team incentives for credibly employing such stochastic compensation. In an optimal contract, low- and high-performance agents are equally rewarded if most agents achieve high performance. Team incentives can be optimal even when there are only two agents and the degree of loss aversion is not large.

Keywords: Moral Hazard; Loss Aversion; Stochastic Compensation; Team Incentives; Reference-Dependent Preferences (search for similar items in EconPapers)
JEL-codes: D03 D86 M12 M52 (search for similar items in EconPapers)
Pages: 37 pages
Date: 2013-07, Revised 2013-07
New Economics Papers: this item is included in nep-cbe, nep-cta, nep-mic, nep-ore and nep-upt
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Persistent link: https://EconPapers.repec.org/RePEc:kgu:wpaper:107

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