Solomonic Separation: Risk Decisions as Productivity Indicators
A principal provides budgets to agents (e.g., divisions of a firm or the principal's children) whose expenditures provide her benefits, either materially or because of altruism. Only agents know their potential to generate benefits. We prove that if the more "productive" agents are also more risk-tolerant (as holds in the sample of individuals we surveyed), the principal can screen agents and bolster target efficiency by offering a choice between a nonrandom budget and a two-outcome risky budget. When, at very low allocations, the ratio of the more risk-averse type's marginal utility to that of the other type is unbounded above (e.g., as with CRRA), the first-best is approached. -- A biblical opening enlivens the analysis.
We thank John Pratt for help with the proof of Lemma 1, Carmen Tanner and Michael Kosfeld for help with the survey, Mario Häfeli and Ramona Westermann for research assistance, and the editor, the referee, and participants in various seminars for helpful comments. Wagner thanks the Swiss Finance Institute, the NCCR FINRISK and the University of Zurich Research Priority Program "Finance and Financial Markets" for support. This paper is forthcoming in the Journal of Risk and Uncertainty. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
Nolan Miller & Alexander Wagner & Richard Zeckhauser, 2013. "Solomonic separation: Risk decisions as productivity indicators," Journal of Risk and Uncertainty, Springer, vol. 46(3), pages 265-297, June. citation courtesy of