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Contracting Probability Distortions

Victor H. Gonzalez-Jimenez ()
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Victor H. Gonzalez-Jimenez: https://econ.univie.ac.at/

Vienna Economics Papers from University of Vienna, Department of Economics

Abstract: I introduce a contract designed to take advantage of the regularity that individuals distort probabilities. With this contract, the principal could activate the probability distortions that are inherent in the agent and use these distortions to incentivize the agent to perform a relevant task. This is because in the contract, the principal could choose the probability that the agent’s compensation depends on his own performance on the task. Distortions of such probability generate higher or lower motivation toper form the task. A theoretical framework and an experiment demonstrate that the proposed contract yields higher output than a traditional contract when both contracts o?er similar monetary incentives. However, the probability speci?ed by the principal is critical to achieving this result. Small probabilities yield higher levels of performance, whereas medium or high probabilities yield no performance di?erences between the contracts. The degree to which individuals overweight small probabilities explains these ?ndings.

JEL-codes: C91 C92 J16 J24 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cta and nep-hrm
Date: 2019-01
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