ECOS3003 Lecture Notes - Lecture 8: Supermajority, Longrun, Random Variable
30 Jul 2018
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The basic problem: owners and employees have different objectives need to motivate employees to work in fir(cid:373)(cid:859)s i(cid:374)terest. Incentive problems exist because of conflicts of interest (employers / employees) if align interests no problems. Incentive problems do not occur if actions are observable and contractible. In the market, employees need to be compensated for effort. Most employees are risk-averse; risk aversion limits scope to sell firm completely to employees: team production (free-rider problems). Trading opportunity; reduce risk faced by risk-averse agent. Principle: surplus increased when risk is borne by the risk-neutral party (but not by the risk-averse party). Effective incentive contracts have two complications: motivating employees; and, sharing risks more effectively. In an incentive contract: changes in the fixed component do not change the effort level of the agent, changes in marginal return from effort (incentive coefficient) increase effort. party, risk-lover.
