behavioral contract theory abstract this review provides a critical survey of psychology and economics behavioral economics research in contract theory first i introduce the theories of individual decision making most

incentives productivity and labor contracts the relationship between age earnings profiles and worker incentives is examined by contrasting wage and salary workers with the self employed it is argued that the steepness of wage and salary workers age earnings profiles reflects the desire to provide work incentives to those workers since self employed workers do not face this agency problem they are used as a benchmark to gauge productivity empirical support of the proposition is provided and the effects of human capital accumulation are separated empirically from incentive effects the most important conclusion is that under some strong assumptions most of the slope in age earnings profiles is accounted for by the desire to provide incentives rather than by on the job training

is tiger woods loss averse persistent bias in the face of experience competition and high stakes although experimental studies have documented systematic decision errors many leading scholars believe that experience competition and large stakes will reliably extinguish biases we test for the presence of a fundamental bias loss aversion in a high stakes context professional golfers performance on the pga tour golf provides a natural setting to test for loss aversion because golfers are rewarded for the total number of strokes they take during a tournament yet each individual hole has a salient reference point par we analyze over 2 5 million putts using precise laser measurements and find evidence that even the best golfers including tiger woods show evidence of loss aversion jel d03 d81 l83

threat of dismissal incentive or sorting many people are fired from their jobs for poor performance however it is difficult to distinguish whether they are fired because they are not well suited for their job sorting explanation or because the firms are trying to provide incentives for effort incentive explanation this article develops a dynamic incentive model of dismissal and proposes a methodology to distinguish between these two explanations the methodology is based on learning by doing and changes in the slope of dismissal probability with respect to tenure using personnel data from a large u s company this study finds significant evidence for the incentive explanation

implications of ethnic diversity ethnically differentiated societies are often regarded as dysfunctional with poor economic performance and a high risk of violent civil conflict the author distinguishes between dominance in which one group constitutes a majority and fractionalization in which there are many small groups in terms of overall economic performance the research shows that both theoretically and empirically fractionalization is normally unproblematic in democracies although it can be damaging in dictatorships in terms of the risk of civil war the author shows that both theoretically and empirically fractionalization actually makes societies safer while dominance increases the risk of conflict a policy implication is that fractionalized societies are viable and secession should be discouraged

multitask agency and contract choice an empirical exploration the multitask agency problem is examined empirically using contracts between private integrated oil companies and their service stations in the city of vancouver the empirical tests assess how variations in the characteristics of one task affect the choice of agent compensation scheme for another comparative statics from the model predict that higher powered incentives will be offered for gasoline sales when the secondary activity is not highly complementary with gasoline retailing where complementarity is measured by the cross price demand effect the covariation in uncertainty and the degree of effort substitutability copyright 1996 by economics department of the university of pennsylvania and the osaka university institute of social and economic research association

the social efficiency of fixed wages this paper analyzes a model in which fixed wages and layoffs may be the most efficient way to organize employment contracts when wages fluctuate to reallocate labor among firms workers must make costly decisions and may undertake excessive search in contrast if all firms reallocate labor with layoffs and new hires at fixed wages only those workers laid off will have decisions to make the lower decision costs of the fixed wage contract may more than compensate for the resource cost of the unemployment it causes a novel feature of the model is the result that the socially optimal contract when chosen by all firms may not be the privately optimal contract

reputation and hierarchy in dynamic models of employment the employment relationship with employees ability and their actions both private information thus combining adverse selection with moral hazard is modeled as a repeated game with self enforcing contracts being perfect bayesian nash equilibria under termination contracts the equilibrium contract structure consists of a hierarchy of ranks finite in number even though ability is continuous reputation acts as an effective device for worker discipline without the need for involuntary unemployment selection by bonding is not in general incentive compatible but selection by promotion of employees through the ranks is many other features correspond to observed employment structures

ex ante randomization in agency models we consider how a principal can use randomized strategies in designing optimal contracts in agency settings we distinguish between ex post randomization overfee schedulesfollowing act selection by the agent and ex ante randomization overfee schedules before act selection we show that ex ante randomization may be efficient in both full information and private information settings under certain assumptions regarding preferences and the production technology it is particularly significant that additive separability and concavity ofthe agent s utility function as well as concavity of the production function do not rule out efficient ex ante randomized contracts in private information settings although as is known they rule out ex post randomization

quality improvements and the incentive to leapfrog abstract in a model of an uncovered market of vertically differentiated products incentives of non identical duopolists to improve the technological maximum quality are analyzed it is assumed that initially firms offer products with different qualities and that the r d cost function changes exogenously this induces a reconsideration of firms quality decisions both firms have the same r d costs for improving the maximum quality quality changes within the existing quality range are assumed to incur only fixed adjustment costs it is shown that the firm which initially is in the low quality position always has a higher incentive to improve industry s quality than its rival if adjustments costs are sufficiently high persistence of dominance may occur for a low degree of initial differentiation low adjustment costs and r d cost functions with a high slope

competition and price variation when consumers are loss averse we modify the salop 1979 model of price competition with differentiated products by assuming that consumers are loss averse relative to a reference point given by their recent expectations about the purchase consumers sensitivity to losses in money increases the price responsiveness of demand and hence the intensity of competition at higher relative to lower market prices reducing or eliminating price variation both within and between products when firms face common stochastic costs in any symmetric equilibrium the markup is strictly decreasing in cost even when firms face different cost distributions we identify conditions under which a focal price equilibrium where firms always charge the same focal price exists and conditions under which any equilibrium is focal

a test of lazear s theory of delayed payment contracts according to lazear workers and firms enter into long term implicit contracts that discourage shirking and malfeasance by shifting compensation to the end of the contract such delayed payment contracts are less likely to occur in jobs in which it is comparatively simple to monitor worker effort this paper uses data from the national longitudinal survey and the dictionary of occupational titles to test that hypothesis in particular it tests whether jobs that involve repetitive tasks tend to be characterized by an absence of pensions mandatory retirement long job tenures and high wages for older workers

incentives learning and compensation a theoretical and empirical investigation of managerial labor contracts this article analyzes properties and implications of multiperiod managerial labor contracts under two alternative hypotheses incentives in which productivity depends on unobservable effort and learning in which ability is unknown and is revealed over time shared and conflicting implications of these competing models are developed in terms of experienceearnings profiles and the relation between compensation and performance i empirically examine these theoretical results by using a longitudinal sample of 1 488 chief executive officers followed from 1974 1985 the data yield mixed evidence that generally supports the learning hypothesis over the incentive hypothesis

multitask agency problems focus and task clustering abstract this short paper discusses recent insights of multitask agency theory it considers in turn the issues of effort substitution conflicts between tasks and implicit incentives and mission it concludes by addressing the problem of optimal task clustering

multi dimensional reference dependent preferences in sealed bid auctions how most laboratory experiments differ from the field abstract we study bidding behavior in first and second price sealed bid auctions with loss averse agents our model predicts overbidding in first price induced value auctions consistent with evidence from most laboratory experiments substantially different bidding behavior could result in commodity auctions where money and auction item are consumed along different dimensions of the consumption space differences also result in second price auctions our study thereby indicates that transferring qualitative behavioral findings from induced value laboratory experiments to the field may be problematic if subjects are loss averse

incentives for helping on the job theory and evidence recent advances in incentive theory stress the multidimensional nature of agent effort and specifically cases where workers affect one anothers performance through helping efforts this article models helping efforts as determined by the compensation package and task allocation the model is tested with australian evidence on reported helping efforts within work groups the evidence consistently supports the hypothesis that helping efforts are reduced while individual efforts are increased when promotion incentives are strong piece rates and profit sharing appear to have little effect on helping efforts while task variety and helping efforts are positively correlated

disappointment in decision making under uncertainty decision analysis requires that two equally desirable consequences should have the same utility and vice versa most analyses of financial decision making presume that two consequences with the same dollar outcome will be equally preferred however winning the top prize of 10 000 in a lottery may leave one much happier than receiving 10 000 as the lowest prize in a lottery this paper explores the implications of disappointment a psychological reaction caused by comparing the actual outcome of a lottery to one s prior expectations for decision making under uncertainty explicit recognition that decision makers may be paying a premium to avoid potential disappointment provides an interpretation for some known behavioral paradoxes and suggests that decision makers may be sensitive to the manner in which a lottery is resolved the concept of disappointment is integrated into utility theory in a prescriptive model

a theory of disappointment aversion an axiomatic model of preferences over lotteries is developed it is shown that this model is consistent with the allais paradox includes expected utility theory as a special case and is only one parameter beta richer than the expected utility model allais paradox type behavior is identified with positive values of beta preferences with positive beta are said to be disappointment averse it is shown that risk aversion implies disappointment aversion and that the arrow pratt measures of risk aversion can be generalized in a straight forward manner to the current framework copyright 1991 by the econometric society

reference dependent risk attitudes we use koszegi and rabin s 2006 model of reference dependent utility and an extension of it that applies to decisions with delayed consequences to study preferences over monetary risk because our theory equates the reference point with recent probabilistic beliefs about outcomes it predicts specific ways in which the environment influences attitudes toward modest scale risk it replicates classical prospect theory including the prediction of distaste for insuring losses when exposure to risk is a surprise but implies first order risk aversion when a risk and the possibility of insuring it are anticipated a prior expectation to take on risk decreases aversion to both the anticipated and additional risk for large scale risk the model allows for standard consumption utility to dominate reference dependent gain loss utility generating nearly identical risk aversion across situations

managerial incentive problems a dynamic perspective the paper studies how a person s concern for a future career may influence his or her incentives to put in effort or make decisions on the job in the model the person s productive abilities are revealed over time through observations of performance there are no explicit output contingent contracts but since the wage in each period is based on expected output and expected output depends on assessed ability an implicit contract links today s performance to future wages an incentive problem arises from the person s ability and desire to influence the learning process and therefore the wage process by taking unobserved actions that affect today s performance the fundamental incongruity in preferences is between the individual s concern for human capital returns and the firm s concern for financial returns the two need be only weakly related it is shown that career motives can be beneficial as well as detrimental depending on how well the two kinds of capital returns are aligned it is well understood by now that informational externalities may place special demands on the organization of economic exchange simple price mediated markets will frequently fail in the presence of asymmetric information in that case more elaborate contractual arrangements have to be used as substitutes for the price system lately considerable effort has been devoted to the analysis of contracting under incomplete information with the objective to understand the range of economic institutions that emerge in response to the failure of the price system the analysis of moral hazard has played a prominent role in this development moral hazard problems arise when for some reason or another transacting parties cannot contract contingent on the delivery of the good for instance in buying labour services it may be that the amount of labour supplied is not directly observable precluding a simple exchange of wage for labour as a partial remedy to this problem an imperfect mutually observed signal about the supply of labour can be used as a proxy in the contract frequently output is taken as such a proxy the drawback is that output is often influenced by other factors than labour input which induce undesirable risk into the contract one is therefore faced with a tradeoff between allocating risk associated with incomplete observability and providing incentives for a proper supply of labour gaining insight into this tradeoff is important not only for understanding contracting in the small e g managerial incentive schemes but also because it is closely related to the fundamental tension between equity and efficiency in the society as a whole while our understanding of moral hazard has advanced a lot in past years it is clear that much work remains an important question that has received little attention until

implicit contracts incentive compatibility and involuntary unemployment this paper considers the enforceability of employment contracts when employees performance cannot be verified in court so that piece rate contracts are not legally enforceable part i shows that there exists a variety of self enforcing implicit contracts modelled as perfect equilibria in a repeated game and characterizes all the wage and performance outcomes that can be implemented implementation requires a strictly positive surplus from employment the form of the contract depending on how this surplus is divided between firm and employee piece rate contracts and contracts with an informally agreed bonus can be made self enforcing but the use of severance pay and bonding does not extend the set of implementable allocations the resulting contracts resemble actual labor contracts more than do the contracts in standard principal agent models part ii analyses market equilibrium with these contracts also modelled as perfect equilibria in a repeated game and shows that many such equilibria exist unfilled vacancies and unemployed workers can co exist despite the existence of contracts that are potentially mutually beneficial for those jobs that are filled any division of the potential surplus is possible so that the market can have at the same time involuntary unemployment and vacancies that are unfilled despite filled jobs earning positive profits as a criterion for selecting equilibria a notion of renegotiation proofness is applied then either all workers are employed or all jobs filled but any division of the potential surplus is still possible the paper explores what further restrictions on beliefs give rise to a walrasian outcome in which all the potential surplus goes to the short side of the market and to an efficiency wage type outcome in which the potential surplus goes to the long side

expectations as endowments evidence on reference dependent preferences from exchange and valuation experiments while evidence suggests that people evaluate outcomes with respect to reference points little is known about what determines them we conduct two experiments that show that reference points are determined at least in part by expectations in an exchange experiment we endow subjects with an item and randomize the probability they will be allowed to trade subjects that are less likely to be able to trade are more likely to choose to keep their item in a valuation experiment we randomly assign subjects a high or low probability of obtaining an item and elicit their willingness to accept for it the high probability treatment increases valuation of the item by 20 30 copyright 2011 oxford university press

ethnic diversity and social capital in indonesia this paper uses the variations of ethnic diversity between districts in indonesia to show that diversity leads to lower social capital outcomes i find that distinguishing between ethnic polarization and fractionalization matters for the results as polarization has a larger negative effect the results cannot entirely be attributed to selection on unobservables and at least part of the relationship should be interpreted as causal finally diversity seems to increase tolerance despite its negative effect on other social capital variables such as trust perceived safety and participation to community activities and voting in elections

the political economy of the maoist conflict in india an empirical analysis we study the maoist naxalite conflict in india by constructing a comprehensive district level database combining conflict data from four different terrorism databases to socioeconomic and geography data from myriad sources using data on 360 districts for three time periods we find that land inequality and lower incomes are important factors behind the conflict exploiting the micro structure of the data we show that growth of incomes of scheduled tribes significantly decreases the intensity of the conflict finally we show that historical property rights institutions from colonial times that go back centuries affect present day conflict outcomes

relational incentive contracts standard incentive theory models provide a rich framework for studying informational problems but assume that contracts can be perfectly enforced this paper studies the design of self enforced relational contracts i show that optimal contracts often can take a simple stationary form but that self enforcement restricts promised compensation and affects incentive provision with hidden information it may be optimal for an agent to supply the same inefficient effort regardless of cost conditions with moral hazard optimal contracts involve just two levels of compensation this is true even if performance measures are subjective in which case optimal contracts terminate following poor performance jel c73 d82 l14

is the endowment effect an expectations effect a hallmark result within behavioral economics is that individuals choices are affected by current endowments a recent theory due to k szegi and rabin 2006 quarterly journal of economics 121 1133 1165 explains such endowment effect with a model of expectations based reference dependent preferences departing from past work we conduct complementary experiments to disentangle expectations verified probabilistic beliefs held by subjects from other features of endowment such as assignment to a good hence allowing us to compare the effect of expectations with that of other variations while mere assignment can affect choices we do not find a large role in the effect for k szegi rabin expectations

ethnic diversity social sanctions and public goods in kenya abstract this paper examines ethnic diversity and local public goods in rural western kenya the identification strategy relies on the stable historically determined patterns of ethnic land settlement ethnic diversity is associated with lower primary school funding and worse school facilities and there is suggestive evidence that it leads to poor water well maintenance the theoretical model illustrates how inability to impose social sanctions in diverse communities leads to collective action failures and we find that school committees in diverse areas do impose fewer sanctions on defaulting parents we relate these results to the literature on social capital and economic development and discuss implications for decentralization in less developed countries

payment systems and the structure of inequality conceptual issues and an analysis of salespersons in department stores output related payment systems such as commissions and piece rates are common in many jobs their central feature is that the wage of an employee is tied directly to her current performance focusing on salespersons in department stores the author considers wage differences under three payment systems a straight salary a straight commision and a salary plus commission four conceptions of wage inequalities under the three systems are contrasted a risk sharing a bargaining a sorting and a social status interpretation the empirical analyses compare the pay schemes and wages of approximately 63 000 salespersons in 178 department stores in 1981

wage increases and the dynamics of reciprocity we investigate how workers performance is affected by the timing of wages in a real effort experiment in all treatments agents earn the same wage sum but wage increases are distributed differently over time we find that agents work harder under increasing wage profiles if they do not know these profiles in advance a profile that continuously increases wages by small amounts raises performance by about 15 relative to a constant wage the effort reactions can be organized by a model in which agents reciprocally respond to wage impulses comparing wages to an adaptive reference standard determined by the previous wage

understanding variations in local conflict evidence and implications from indonesia recent studies of large scale headline conflicts have excluded consideration of local conflict in large part due to the absence of representative data at low levels of geographic specification this paper is a first attempt to correct for that by assessing the incidence impacts and patterns of local conflict in indonesia we employ a combination of qualitative fieldwork with an exploratory statistical analysis of the 2003 village potential statistics collected by the bureau of statistics potensi desa podes which maps conflict across all of indonesia s villages neighborhoods violent conflict can be observed throughout the archipelago the qualitative analysis shows that local conflicts vary in form and impacts across districts and that local factors are key the quantitative analysis which excludes high conflict areas of indonesia confirms the importance of economic factors with positive correlations between violent conflict and poverty inequality and variables measuring economic development clustering of ethnic groups and ill defined property rights were also positively associated with violence

frames of mind in intertemporal choice recent research has demonstrated that choices between gambles are systematically influenced by the way they are expressed kahneman and tversky s prospect theory kahneman d a tversky 1979 prospect theory an analysis of decision under risk econometrica472 363 391 explains many of these framing effects as shifts in the point of reference from which prospects are evaluated this paper demonstrates the applicability of the reference point concept to intertemporal choice three experiments demonstrate that when people choose between immediate and delayed consumption the reference point used to evaluate alternatives can significantly influence choice the first study elicited relative preference for immediate and delayed consumption using three methods each of which differently framed choices between alternatives offering identical end state consumption the conventional discounted utility model predicts that the three methods of elicitation should yield similar estimates of time preference but preferences were found to differ in accordance with a reference point model the second and third studies extend and replicate the results from the first the third using real rather than hypothetical choices

credit access and college enrollment does access to credit explain the gap in schooling attainment between children from richer and poorer families i present new evidence on this important question based on the causal effects of two

reference dependent subjective expected utility abstract a reference dependent generalisation of subjective expected utility theory is presented in this theory preferences between acts depend both on final outcomes and on reference points which may be uncertain acts it is characterised by a set of axioms in a savage style framework a restricted form of the theory separates attitudes to end states encoded in a satisfaction function from attitudes to gains and losses of satisfaction given weak additional assumptions the restricted theory excludes cycles of choice explains observed disparities between willingness to pay and willingness to accept valuations of lotteries and predicts preference reversal

an analysis of the principal agent problem most analyses of the principal agent problem assume that the principal chooses an incentive scheme to maximize expected utility subject to the agent s utility being at a stationary point an important paper of mirrlees has shown that this approach is generally invalid we present an alternative procedure if the agent s preferences over income lotteries are independent of action we show that the optimal way of implementing an action by the agent can be found by solving a convex programming problem we use this to characterize the optimal incentive scheme and to analyze the determinants of the seriousness of an incentive problem

power ownership and tourism in small islands evidence from indonesia this paper examines the political economy of tourism development in islands and uses gili trawangan indonesia as a case study a longitudinal study drawing from fieldwork contributes to the discussion of how different types of power shape community development and how the effects of hosting international tourism play an explicit role analysis using barnett and duvall s taxonomy of power model reveals the interplay between the types of power over time and its effects on different actors results raise questions for less developed countries and particularly islands concerning the social costs of using tourism for development

estimating a firm s age productivity profile using the present value of workers earnings in hiring new workers risk neutral employers equate the present expected value of each worker s compensation to the present expected value of his her productivity data detailing how present expected compensation varies with the age of hire embed therefore information about how productivity varies with age this paper infers age productivity profiles using data on the present expected value of earnings of new hires of a fortune 1000 firm for each of the five occupation sex groups considered productivity falls with age with productivity exceeding earnings for young workers and vice versa for older workers

disappointment and dynamic consistency in choice under uncertainty the central proposition of disappointment theory is that an individual forms expectations about uncertain prospects and that if the actual consequence turns out to be worse than or better than that expectation the individual experiences a sensation of disappointment or elation generating a decrement or increment of utility which modifies the basic utility derived from the consequence by incorporating a simple disappointment elation function into a model of individual choice many observed violations of conventional expected utility axioms including violations of savage s sure thing principle and the isolation effect can be predicted and defended as rational and dynamically consistent behaviour

pay equality and industrial politics personnel managers often argue that equitable pay treatment manifested as wage compression is useful because it reduces disharmony among workers but it is far from obvious that a compressed salary structure is morale improving since better workers may feel disenchanted by this scheme however when workers rewards are based on relative comparisons salary compression reduces uncooperative behavior that is detrimental to the firm relative comparisons imply that some reference group must be selected the major result is that within the relevant groups some wage compression is efficient

short term contracts and long term agency relationships abstract long term contracts are valuable only if optimal contracting requires commitment to a plan today that would not otherwise be adopted tomorrow we show that commitments are unnecessary and hence short term contracts are sufficient if 1 all public information can be used in contracting 2 the agent can acess a bank on equal terms with the principal 3 recontracting takes place with common knowledge about technology and preferences and 4 the frontier of expected utility payoffs generated by the set of incentive compatible contracts is downward sloping at all times

clumped or piecewise evidence on preferences for information in this paper we examine individuals attitudes toward the timing of information we test a theoretical prediction that people prefer to get information clumped together rather than piecewise we conduct a controlled lab experiment where subjects participate in a lottery and can choose between different resolutions of uncertainty clumped or piecewise and analyze which kind of resolution is preferred two additional treatments allow us to get a quantitative measure of subjects preferences over different information structures our data provide little support for a systematic aversion to piecewise information on the aggregate level in additional treatment conditions we demonstrate the robustness of our findings and explore potential explanations data as supplemental material are available at http dx doi org 10 1287 mnsc 2013 1884 this paper was accepted by john list behavioral economics

the tenuous trade off between risk and incentives empirical work testing for a negative trade off between risk and incentives has not had much success the data suggest a positive relationship between measures of uncertainty and incentives rather than the posited negative trade off 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 firms are content to assign tasks to workers and monitor their inputs by contrast when the situation is more uncertain they delegate responsibility to workers but to constrain their discretion base compensation on observed output

salaries and piece rates compensation can take many forms remuneration can come as pecuniary payments as fringes such as health and pension benefits or as a nonpecuniary reward such as plush office furniture that costs the firm less than it benefits the worker a significant literature has examined the trade offs between pecuniary and nonpecuniary compensation the modern work having been pioneered by rosen 1974 more recently another body of literature has examined the selection of method of total compensation ignoring the distinction between pecuniary and nonpecuniary payment this work has focused on risk and incentive factors it has resulted in comparisons of compensation based on absolute output levels to that based on relative performance it has also led to explorations of the relation of compensation to experience over the work life 2 little attention has been paid to what may be among the most important and obvious distinction in methods of compensation namely the choice between a fixed salary for some period of time that is paying on the basis of input and some workers receive compensation that is specified in advance and not directly contingent on performance instead it depends on an input measure such as hours worked for others compensation is directly related to output this essay is an attempt to predict a firm s choice of compensation method piece rates are defined more rigorously among the more important factors discussed are worker heterogeneity incentives sorting considerations monitoring costs and asymmetric information one result is that salary workers tend to be of lower quality and more homogeneous than are their piece rate counterparts numerous additional results are provided helpful comments by victoria lazear and yoram weiss are gratefully acknowledged support was provided by the department of labor and the national science foundation 1 see lazear and rosen 1981 stiglitz 1981 holmstrom 1982 green and stokey 1983 2 see lazear 1979 1981 and harris and holmstrom in press

a news utility theory for inattention and delegation in portfolio choice recent evidence suggests that investors are inattentive to their portfolios and hire expensive portfolio managers this paper develops a life cycle portfolio choice model in which the investor experiences loss averse utility over news and can ignore his portfolio in such a model the investor prefers to ignore and not rebalance his portfolio most of the time because he dislikes bad news more than he likes good news such that expected news causes a first order decrease in utility consequently the investor has a first order willingness to pay a portfolio manager who rebalances actively on his behalf moreover the investor can diversify over time and his consumption aligns with predictions of mental accounting i structurally estimate the preference parameters by matching stock shares and stock market non participation over the life cycle my parameter estimates are in line with the literature generate reasonable intervals of inattention and simultaneously explain consumption and wealth accumulation over the life cycle here it matters that news utility preserves first order risk aversion even in the presence of stochastic labor income which also causes stock shares to rise in wealth

incentive design under loss aversion compensation schemes often reward success b ut do not penalize failure fixed salaries with stock options or bonuses have this feature yet the standard principal agent model implies that pay is normally monotonically increasing in performance this paper shows that under loss aversion there will be intervals over which pay is insensitive to performance with the use of carrots but not sticks is frequently optimal especially when risk aversion is low and reference income is e ndogenous a further benefit of capping losses for example through options is to discourage reckless behavior by executives seeking to resurrect their fortunes jel f3 f4

repeated moral hazard the role of memory commitment and the access to credit markets abstract the dynamic dimension introduces new questions in moral hazard models thus the roles of memory and commitment have recently raised a marked interest the goal of this paper is to discuss and clarify the issues at hand and to present some new results we show that two conditions are necessary for the optimal long term contract to be implementable via spot contracts first the long term optimum should be renegotiation proof second spot contracts should provide efficient consumption smoothing we discuss how the availability of credit to the agent affects these two prerequisites we also study the hitherto neglected case in which the repetition of the moral hazard problem generates hidden information at recontracting dates the optimal renegotiation proof contract then implements the minimum effort level unless it involves randomized savings

new york city cab drivers labor supply revisited reference dependent preferences with rational expectations targets for hours and income this paper reconsiders whether cabdrivers labor supply decisions reflect reference dependent preferences following botond koszegi and matthew rabin 2006 we construct a model with targets for hours as well as income both determined by rational expectations estimating using henry s farber s 2005 2008 data we show that the reference dependent model can reconcile his 2005 finding that drivers stopping probabilities are significantly related to hours but not income with the negative wage elasticity of hours found by colin camerer et al 1997 and farber 2005 2008 the model yields sensible estimates that avoid farber s 2008 criticism that drivers income targets are too unstable to allow a useful reference dependent model of labor supply

the internal economics of the firm evidence from personnel data we analyze twenty years of personnel data from one firm the hierarchical structure is quite simple and stable career movements suggest that the employee s rate of learning and the firm s learning about ability are important there are promotion fast tracks exit rates vary little with tenure or salary the firm has personnel policies like those described in the internal labor markets literature although several theoretical preconditions for ilms such as ports of entry and exit are lacking job levels are important to compensation but there is also substantial individual variation in pay within levels our companion paper in this issue explores the wage policy of this firm

optimal retention in agency problems this paper studies the interaction between a single long lived principal and a series of short lived agents in the presence of both moral hazard and adverse selection we assume that the principal can influence the agents behavior only through her choice of a retention rule this rule is further required to be sequentially rational i e no precommitment is allowed we provide general conditions under which equilibria exist where a the principal adopts a cut off rule under which agents are retained only when the reward they generate exceeds a critical bound and b agents separate according to type with better agents taking superior actions we show that in equilibrium a retained agent s productivity is necessarily declining over time but that retained agents are also more productive on average than untried agents due to selection effects finally we show that for each given type agents of that type are more productive in the presence of adverse selection than when there is pure moral hazard i e when that type is the sole type of agent in the model nonetheless adding uncertainty about agent types cannot benefit the principal except in uninteresting cases

credit constraints and demand for higher education evidence from financial deregulation abstract we use staggered banking deregulation across states in the united states to examine the impact of the resulting increased credit supply on college enrollment from the 1970s to the early 1990s our research design produces estimates that are not confounded by wealth effects due to changes in income or housing wealth we find that lifting banking restrictions raises college enrollment by about 2 6 percentage points 4 9 we rule out alternative interpretations by examining results for different income groups and bankrupt households we also find similar effects for two year or four year college completion and supporting evidence in household educational borrowing

gender piece rates and wages evidence from matched employer employee data why are women disproportionately on piece rates we investigate three possible explanations 1 women are more likely to be on piece rates because they have a shorter expected tenure than men 2 a greater demand for flexibility between work and home attracts women to work place technologies suitable for variable pay based on individual performance 3 women prefer piece rates because they are subject to less wage discrimination when objective performance measures are available the weight of our empirical evidence supports the third hypothesis the unexplained gender wage gap is substantially smaller in the piece rate regime than in the time wage regime copyright 2004 oxford university press

psychological expected utility theory and anticipatory feelings we extend expected utility theory to situations in which agents experience feelings of anticipation prior to the resolution of uncertainty we show how these anticipatory feelings may result in time inconsistency we provide an example from portfolio theory to illustrate the potential impact of anticipation on asset prices

workers trust funds and the logic of wage profiles this paper defines a concept a worker s trust fund which is useful in analyzing optimal age earnings profiles the trust fund represents what a worker loses if dismissed from a job for shirking in considering whether to work or shirk a worker weighs the potential loss due to forfeiture of the trust fund if caught shirking against the benefits from reduced effort this concept is used to show that the implicit bonding in upward sloping age earnings profiles is not a perfect substitute for an explicit up front performance bond or employment fee it is also shown that the second best optimal earnings profile in the absence of an up front employment fee pays total compensation in excess of market clearing in a variety of stylized cases

career concerns of mutual fund managers we examine the labor market for mutual fund managers using data from 1992 1994 we find that termination is more performance sensitive for younger managers we identify possible implicit incentives created by the termination performance relationship the shape of the termination performance relationship may give younger managers an incentive to avoid unsystematic risk direct effects of portfolio composition may also give younger managers an incentive to herd into popular sectors consistent with these incentives we find that younger managers hold less unsystematic risk and have more conventional portfolios promotion incentives and market responses to managerial turnover are also studied

long term short term and renegotiation on the value of commitment in contracting spot contracting generally involves efficiency losses relative to long term contracting it is proved here that short term contracting and renegotiation allow to achieve long run efficiency when transfers are not limited objectives are conflicting and no relevant asymmetric information appears at recontracting dates this last assumption excludes adverse selection but not moral hazard when technologies and preferences are time separable copyright 1990 by the econometric society

on the theory of reference dependent preferences a theory is proposed in which preferences are conditional on reference points it is related to tversky and kahneman s reference dependent preference theory but is simpler and deviates less from conventional consumer theory preferences conditional on any given reference point satisfy conventional assumptions apart from a continuity condition the only additional restriction is to rule out cycles of pairwise choice the theory is consistent with observations of status quo bias and related effects reference points are treated as subject to change during the course of trade the implications of endogeneity of reference points for behaviour in markets are investigated

intertemporal incentives under loss aversion this paper studies the intertemporal allocation of incentives in a repeated moral hazard model with reference dependent preferences as in k oszegi and rabin 2009 besides consumption utility the agent experiences utility from the change in his beliefs about present and future eort and income when eort plans are rational the prospect of being disappointed by the outcome realization equals that of being pleasantly surprised and hence the loss averse agent is on net hurt by news in contrast to the prediction with classical preferences but consistent with real world contracts if consumption utility is not too concave and news about present income carries suciently larger weight in utility than news about future income a contract setting a current

performance pay and wage inequality an increasing fraction of jobs in the u s labor market explicitly pay workers for their performance using bonus pay commissions or piece rate contracts using data from the panel study of income dynamics we show that compensation in performance pay jobs is more closely tied to both observed and unobserved productive characteristics of workers than compensation in non performance pay jobs we also find that the return to these productive characteristics increased faster over time in performance pay than in non performance pay jobs we show that this finding is consistent with the view that underlying changes in returns to skill due for instance to technological change induce more firms to offer performance pay contracts and result in more wage inequality among workers who are paid for performance thus performance pay provides a channel through which underlying changes in returns to skill get translated into higher wage inequality we conclude that this channel accounts for 21 of the growth in the variance of male wages between the late 1970s and the early 1990s and for most of the increase in wage inequality above the eightieth percentile over the same period

do workers prefer increasing wage profiles we present survey data challenging the assumption implicit in analyses of labor supply that all else being equal workers prefer declining over increasing wage profiles we test several explanations for our results including that a there is something special about wages e g their association with productivity as opposed to other types of payments that induces the preference for increasing wages b utility depends not only on absolute levels of consumption but also on changes in consumption over time and c respondents who prefer increasing wage profiles are irrational and would change their behavior if the rationale for preferring declining wages were explained

unpacking the effect of decentralized governance on routine violence lessons from indonesia summary we study the effect of decentralization on routine violence in indonesia we unpack decentralization along multiple dimensions and consider the individual effects of local elections the creation of new administrative units fiscal transfers and local public service delivery we use comprehensive data from indonesia s national violence monitoring system nvms a new dataset that records the incidence and impact of violence in indonesia we use these data to examine the relationship between the different dimensions of decentralization and different types of local violence in indonesian districts during 2001 10 our analyses suggest that there is a positive association between local service delivery and at least some forms of violence we argue that the positive effect of service delivery on violence is due to newly generated distributive conflicts among local ethnic groups around the control over and access to services by comparison district splitting and the introduction of direct elections of district heads are negatively associated with some forms of violence there is little evidence that fiscal transfers in general mitigate conflict

on repeated moral hazard with discounting in this paper we analyze optimal contracts in an infinitely repeated agency model in which both the principal and agent discount the future we show that there is a stationary representation of the optimal contract when the agent s conditional discounted expected utility is used as a state variable this representation reduces the multi period problem to a static variational problem which can be analyzed using standard variational techniques this reduction is used to obtain several properties of the contract

competition and relational contracts the role of unemployment as a disciplinary device when workers are faced with the threat of unemployment their relationship with a particular firm becomes valuable as a result a worker may comply with the terms of a relational contract that demands high effort even when performance is not enforceable by a third party but can relational contracts motivate high effort when workers can easily find alternative jobs we examine how competition for labor affects the emergence of relational contracts and their effectiveness in overcoming moral hazard in the labor market we show that effective relational contracts do emerge in a market with excess demand for labor long term relationships turn out to be less frequent when there is excess demand for labor than they are in a market characterized by exogenous unemployment however stronger competition for labor does not impair labor market efficiency higher wages induced by competition lead to higher effort out of concerns for reciprocity

the multiperiod principal agent problem in repeated principal agent models long term contracts can improve on short term contracts only if they commit either principal or agent to a payoff in some future circumstance lower than could be obtained from a short term contract negotiated if that circumstance occurs we show that efficient contracting under moral hazard alone does not require long term commitment from the principal provided a short term contract can punish the agent sufficiently in a sense made precise it requires no commitment from the agent either then linking payoffs in one period to outcomes in previous periods does not improve the tradeoff between incentives and risk sharing

reference dependent consumption plans we develop a rational dynamic model in which people are loss averse over changes in beliefs about present and future consumption because changes in wealth are news about future consumption preferences over money are reference dependent if news resonates more when about imminent consump tion than when about future consumption a decision maker might to generate pleasant surprises overconsume early relative to the optimal committed plan increase immediate consumption following surprise wealth increases and delay decreasing consumption following surprise losses since higher wealth mitigates the effect of bad news people exhibit an unambiguous first order precautionary savings motive

reference points and effort provision a key open question for theories of reference dependent preferences is what determines the reference point one candidate is expectations what people expect could affect how they feel about what actually occurs in a real effort experiment we manipulate the rational expectations of subjects and check whether this manipulation influences their effort provision we find that effort provision is significantly different between treatments in the way predicted by models of expectation based reference dependent preferences if expectations are high subjects work longer and earn more money than if expectations are low

do people anticipate loss aversion there is growing interest in the use of loss contracts that offer performance incentives as up front payments that employees can lose standard behavioral models predict a trade off in the use of loss contracts employees will work harder under loss contracts than under gain contracts but anticipating loss aversion they will prefer gain contracts to loss contracts in a series of experiments we test these predictions by measuring performance and preferences for payoff equivalent gain and loss contracts we find that people indeed work harder under loss than gain contracts as the theory predicts surprisingly rather than a preference for the gain contract we find that people actually prefer loss contracts in exploring mechanisms for our results we find suggestive evidence that people do anticipate loss aversion but select into loss contracts as a commitment device to improve performance using one bias loss aversion to address another dynamic inconsistency data as supplemental material are a