ECOS3003 Lecture Notes - Lecture 9: Risk Premium, Moral Hazard, Horizon Problem
30 Jul 2018
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Can observe output, but not effort: output is the only measure of performance. Employee works independently (no team): any mutually beneficial contract feasible. Whe(cid:374) these issues a(cid:396)e (cid:396)ela(cid:454)ed, ho(cid:449) do fi(cid:396)(cid:373)s set the sta(cid:374)da(cid:396)d fo(cid:396) the (cid:858)a(cid:448)e(cid:396)age (cid:449)o(cid:396)ke(cid:396)(cid:859) (cid:894)(cid:271)e(cid:374)(cid:272)h(cid:373)a(cid:396)ki(cid:374)g(cid:895): time and motion studies, past performance. Piece rate that does not change; frequent job rotation (loss of specific hc). Some measures look at one aspect of output. Opportunism: gaming: performance evaluation can create perverse behaviour horizon problem. Relative performance evaluation: uses output of other employees to adjust an employee(cid:859)s (cid:272)o(cid:373)pe(cid:374)satio(cid:374) contract: aims to reduce chance that uncontrollable factors affect performance. Firms often augment their objective explicit measures with subjective yet comprehensive measures of performance subjective performance evaluation (spe). Spe expensive to accurately measure all things: multiple tasks: pay for one output, not the other bias effort towards first output. Influence costs: reneging (firm reneges on promise to reward good work).
