NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

The Tenuous Tradeoff Between Risk and Incentives

Canice Prendergast

NBER Working Paper No. 7815
Issued in July 2000
NBER Program(s):   LS

Empirical work testing for a negative tradeoff between risk and incentives, a cornerstone of agency theory, has not had much success. Indeed, the data seem to suggest a positive relationship between measures of uncertainty and incentives, rather than the posited negative tradeoff. I argue that the existing literature fails to account for an important effect of uncertainty on incentives through the allocation of responsibility to employees. When workers operate in certain settings, the activities that they should engage in are well known, and firms are content to assign tasks to workers and monitor their inputs. By contrast, when the situation is more uncertain, firms know less about how workers should be spending their time. As a result, the delegate responsibility to workers but, to constraint heir discretion, base compensation on observed output. Hence, uncertainty and output-based pay are positively related. I argue that parts of the existing empirical literature are better explained through this lens than with the standard model.

download in pdf format
   (1773 K)

email paper

This paper is available as PDF (1773 K) or via email.

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w7815

Published: Prendergast, Canice. "The Tenuous Trade-Off Between Risk And Incentives," Journal of Political Economy, 2002, v110(5,Oct), 1071-1102.

Users who downloaded this paper also downloaded these:
Gibbons w6695 Incentives in Organizations
Gibbons w5705 Incentives and Careers in Organizations
Hilt w11960 The Negative Trade-off Between Risk and Incentives: Evidence from the American Whaling Industry
Prendergast and Topel w4427 Favoritism in Organizations
Shleifer and Vishny w5554 A Survey of Corporate Governance
 
Publications
Activities
Meetings
NBER Videos
Data
People
About

Support
National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us