In economics , an agent is an actor (more specifically, a decision maker ) in a model of some aspect of the economy . Typically, every agent makes decisions by solving a well- or ill-defined optimization or choice problem.
83-412: The principal–agent problem refers to the conflict in interests and priorities that arises when one person or entity (the " agent ") takes actions on behalf of another person or entity (the " principal "). The problem worsens when there is a greater discrepancy of interests and information between the principal and agent, as well as when the principal lacks the means to punish the agent. The deviation from
166-469: A principal . In agent-based computational economics , corresponding agents are "computational objects modeled as interacting according to rules" over space and time, not real people. The rules are formulated to model behavior and social interactions based on stipulated incentives and information. The concept of an agent may be broadly interpreted to be any persistent individual, social, biological, or physical entity interacting with other such entities in
249-455: A certain degree of pride in their work, and that introducing performance-related pay can destroy this "psycho-social compensation", because the exchange relation between employer and employee becomes much more narrowly economic, destroying most or all of the potential for social exchange. Evidence for this is inconclusive—Deci (1971), and Lepper, Greene and Nisbett (1973) find support for this argument; Staw (1989) suggests other interpretations of
332-428: A few). Ongoing periodic catastrophic organizational failure is directly incentivized by tournament and other superstar /winner-take-all compensation systems (Holt 1995). Tournaments represent one way of implementing the general principle of "deferred compensation", which is essentially an agreement between worker and firm to commit to each other. Under schemes of deferred compensation, workers are overpaid when old, at
415-457: A good tip, they cut into the profit margin of the restaurant. In addition, a server may dote on generous tippers while ignoring other customers, and in rare cases harangue bad tippers. Part of this variation in incentive structures and supervisory mechanisms may be attributable to variation in the level of intrinsic psychological satisfaction to be had from different types of work. Sociologists and psychologists frequently argue that individuals take
498-532: A higher chance of bending and or breaking the rules to win. Nelson (2007) also indicated that when the larger the price (incentive) the more inclined the agent (employee in this case) is to increase their effort parameter from Neilson's studies. A major problem with tournaments is that individuals are rewarded based on how well they do relative to others. Co-workers might become reluctant to help out others and might even sabotage others' effort instead of increasing their own effort (Lazear 1989, Rob and Zemsky 1997). This
581-648: A higher rate than the hourly rate implied by the salary). The way in which these mechanisms are used is different in the two parts of the economy which Doeringer and Piore called the "primary" and "secondary" sectors (see also dual labour market ). The secondary sector is characterised by short-term employment relationships, little or no prospect of internal promotion, and the determination of wages primarily by market forces. In terms of occupations, it consists primarily of low or unskilled jobs, whether they are blue-collar (manual-labour), white-collar (e.g., filing clerks), or service jobs (e.g., waiters). These jobs are linked by
664-634: A kind of " disintermediation "—targeting certain measurable variables may cause others to suffer. For example, teachers being rewarded by test scores of their students are likely to tend more towards teaching 'for the test', and de-emphasise less relevant but perhaps equally or more important aspects of education; while AT&T 's practice at one time of paying programmers by the number of lines of code written resulted in programs that were longer than necessary—i.e., program efficiency suffering (Prendergast 1999, 21). Following Holmström and Milgrom (1990) and Baker (1992), this has become known as "multi-tasking" (where
747-401: A looser, more extended sense, as workers who consistently work harder and better are more likely to be promoted (and usually paid more), compared to the narrow definition of "pay-for-performance", such as piece rates. This discussion has been conducted almost entirely for self-interested rational individuals. In practice, however, the incentive mechanisms which successful firms use take account of
830-583: A method of forced saving, or as an indicator of personal development. e.g., Loewenstein and Sicherman 1991, Frank and Hutchens 1993.) For example, Akerlof and Katz 1989: if older workers receive efficiency wages, younger workers may be prepared to work for less in order to receive those later. Overall, the evidence suggests the use of deferred compensation (e.g., Freeman and Medoff 1984, and Spilerman 1986—seniority provisions are often included in pay, promotion and retention decisions, irrespective of productivity.) The "principal–agent problem" has also been discussed in
913-411: A principal/agent problem arises." The energy efficiency use of the principal agent terminology is in fact distinct from the usual one in several ways. In landlord/tenant or more generally equipment-purchaser/energy-bill-payer situations, it is often difficult to describe who would be the principal and who the agent. Is the agent the landlord and the principal the tenant, because the landlord is "hired" by
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#1732791403081996-538: A prize structure represents a degree of commitment, both to absolute and to relative wage levels. Lastly when the measurement of workers' productivity is difficult, e.g., say monitoring is costly, or when the tasks the workers have to perform for the job is varied in nature, making it hard to measure effort and/or performance, then running tournaments in a firm would encourage the workers to supply effort whereas workers would have shirked if there are no promotions. Tournaments also promote risk seeking behavior. In essence,
1079-489: A quota of graduated trainees within a year. This causes them to 'rush-graduate' trainees in order to make the quota. In certain cases agency problems may be analysed by applying the techniques developed for financial options , as applied via a real options framework. Stockholders and bondholders have different objective—for instance, stockholders have an incentive to take riskier projects than bondholders do, and to pay more out in dividends than bondholders would like. At
1162-467: A related note, Drago and Garvey (1997) use Australian survey data to show that when agents are placed on individual pay-for-performance schemes, they are less likely to help their coworkers. This negative effect is particularly important in those jobs that involve strong elements of "team production" ( Alchian and Demsetz 1972), where output reflects the contribution of many individuals, and individual contributions cannot be easily identified, and compensation
1245-576: A researcher at the New Zealand Institute for the Study of Competition and Regulation[,] '[i]n theory, tipping can lead to an efficient match between workers' attitudes to service and the jobs they perform. It is a means to make people work hard. Friendly waiters will go that extra mile, earn their tip, and earn a relatively high income...[On the other hand,] if tipless wages are sufficiently low, then grumpy waiters might actually choose to leave
1328-473: A solution to some of the problems outlined. Here, there is "pay-for-performance" in a looser sense over a longer time period. There is little variation in pay within grades, and pay increases come with changes in job or job title (Gibbs and Hendricks 1996). The incentive effects of this structure are dealt with in what is known as " tournament theory " (Lazear and Rosen 1981, Green and Stokey (1983), see Rosen (1986) for multi-stage tournaments in hierarchies where it
1411-406: A subordinated debt and therefore the stock's payoff is truncated by the difference between the face values of the corporation debt and of the bank deposits. Based on this observation, Peleg-Lazar and Raviv (2017) show that in contrast to the classical agent theory of Michael C. Jensen and William Meckling, an increase in variance would not lead to an increase in the value of equity if the bank's debtor
1494-553: A subset of relevant tasks is rewarded, non-rewarded tasks suffer relative neglect). Because of this, the more difficult it is to completely specify and measure the variables on which reward is to be conditioned, the less likely that performance-related pay will be used: "in essence, complex jobs will typically not be evaluated through explicit contracts." (Prendergast 1999, 9). Where explicit measures are used, they are more likely to be some kind of aggregate measure, for example, baseball and American Football players are rarely rewarded on
1577-416: A worker has already exceeded a quota or has no hope of reaching it, versus being close to reaching it—e.g., Healy (1985), Oyer (1997), Leventis (1997). Leventis shows that New York surgeons, penalised for exceeding a certain mortality rate, take less risky cases as they approach the threshold. Courty and Marshke (1997) provide evidence on incentive contracts offered to agencies, which receive bonuses on reaching
1660-515: Is also high. Thus employers effectively choose from a "menu" of monitoring/incentive intensities. This is because monitoring is a costly means of reducing the variance of employee performance, which makes more difference to profits in the kinds of situations where it is also optimal to make incentives intense. The fourth principle is the Equal Compensation Principle , which essentially states that activities equally valued by
1743-481: Is explained why CEOs are paid many times more than other workers in the firm). See the superstar article for more information on the tournament theory. Workers are motivated to supply effort by the wage increase they would earn if they win a promotion. Some of the extended tournament models predict that relatively weaker agents, be they competing in a sports tournaments (Becker and Huselid 1992, in NASCAR racing) or in
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#17327914030811826-512: Is however considerable empirical evidence of a positive effect of compensation on performance (although the studies usually involve "simple" jobs where aggregate measures of performance are available, which is where piece rates should be most effective). In one study, Lazear (1996) saw productivity rising by 44% (and wages by 10%) in a change from salary to piece rates, with a half of the productivity gain due to worker selection effects. Research shows that pay for performance increases performance when
1909-430: Is known in economics, crops up any time agents aren't inclined to do what principals want them to do. To sway them [(agents)], principals have to make it worth the agents' while ... [in the restaurant context,] the better the diner's experience, the bigger the waiter's tip." "In the ... language of the economist, the tip serves as a way to reduce what is known as the classic "principal–agent" problem." According to "Videbeck,
1992-615: Is not available, Holmström (1979) developed the Informativeness Principle to solve this problem. This essentially states that any measure of performance that (on the margin) reveals information about the effort level chosen by the agent should be included in the compensation contract. This includes, for example, Relative Performance Evaluation—measurement relative to other, similar agents, so as to filter out some common background noise factors, such as fluctuations in demand. By removing some exogenous sources of randomness in
2075-564: Is possible to do a certain task. These have been used constructively in the past, particularly in manufacturing. More generally, however, even within the field of objective performance evaluation, some form of relative performance evaluation must be used. Typically this takes the form of comparing the performance of a worker to that of his peers in the firm or industry, perhaps taking account of different exogenous circumstances affecting that. The reason that employees are often paid according to hours of work rather than by direct measurement of results
2158-628: Is shared. Leibowitz and Tollison (1980) find that larger law partnerships typically result in worse cost containment. As a counter, peer pressure can potentially solve the problem (Kandel and Lazear 1992), but this depends on peer monitoring being relatively costless to the individuals doing the monitoring/censuring in any particular instance (unless one brings in social considerations of norms and group identity and so on). Studies suggest that profit-sharing, for example, typically raises productivity by 3–5% (Jones and Kato 1995, Knez and Simester 2001), although there are some selection issues (Prendergast). There
2241-446: Is solvent. The major problem in measuring employee performance in cases where it is difficult to draw a straightforward connection between performance and profitability is the setting of a standard by which to judge the performance. One method of setting an absolute objective performance standard—rarely used because it is costly and only appropriate for simple repetitive tasks—is time-and-motion studies , which study in detail how fast it
2324-474: Is supported empirically by Drago and Garvey (1997). Why then are tournaments so popular? Firstly, because—especially given compression rating problems—it is difficult to determine absolutely differences in worker performance. Tournaments merely require rank order evaluation. Secondly, it reduces the danger of rent-seeking , because bonuses paid to favourite workers are tied to increased responsibilities in new jobs, and supervisors will suffer if they do not promote
2407-440: Is that [its] provision imposes additional risk on workers ..." A typical result of the early principal–agent literature was that piece rates tend to 100% (of the compensation package) as the worker becomes more able to handle risk, as this ensures that workers fully internalize the consequences of their costly actions. In incentive terms, where we conceive of workers as self-interested rational individuals who provide costly effort (in
2490-556: Is that it is often more efficient to use indirect systems of controlling the quantity and quality of effort, due to a variety of informational and other issues (e.g., turnover costs, which determine the optimal minimum length of relationship between firm and employee). This means that methods such as deferred compensation and structures such as tournaments are often more suitable to create the incentives for employees to contribute what they can to output over longer periods (years rather than hours). These represent "pay-for-performance" systems in
2573-407: Is the reason for the common separation of evaluations and pay, with evaluations primarily used to allocate training. Finally, while the problem of compression of ratings originates on the supervisor-side, related effects occur when workers actively attempt to influence the appraisals supervisors give, either by influencing the performance information going to the supervisor: multitasking (focussing on
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2656-475: Is therefore based largely on the output of the team. In other words, pay-for-performance increases the incentives to free-ride, as there are large positive externalities to the efforts of an individual team member, and low returns to the individual (Holmström 1982, McLaughlin 1994). The negative incentive effects implied are confirmed by some empirical studies, (e.g., Newhouse, 1973) for shared medical practices; costs rise and doctors work fewer hours as more revenue
2739-463: The agent or otherwise act in their individual interests rather than in the collective interest of all principals. The multiple principal problem is particularly serious in the public sector. Various mechanisms may be used to align the interests of the agent with those of the principal. In employment, employers (principal) may use piece rates / commissions , profit sharing , efficiency wages , performance measurement (including financial statements ),
2822-416: The agent posting a bond, or the threat of termination of employment to align worker interests with their own. The principal's interests are expected to be pursued by the agent; however, when the interests of the agent and principal differ, a dilemma arises. The agent possesses resources such as time, information, and expertise that the principal lacks. At the same time, the principal does not have control over
2905-412: The agent's ability to act in the agent's own best interests. In this situation, the theory posits that the agent's activities are diverted from following the principal's interests and drive the agent to maximize the agent's interests instead. The principal and agent theory emerged in the 1970s from the combined disciplines of economics and institutional theory. There is some contention as to who originated
2988-423: The agent's income, a greater proportion of the fluctuation in the agent's income falls under their control, increasing their ability to bear risk. If taken advantage of, by greater use of piece rates, this should improve incentives. (In terms of the simple linear model below, this means that increasing x produces an increase in b .) However, setting incentives as intense as possible is not necessarily optimal from
3071-453: The agents thus benefiting the principal. Furthermore, the studies provided a conclusive remark that intrinsic motivation can be increased by utilising the use of non-monetary compensations that provide acknowledgement for the agent. These higher rewards, can provide a principal with the adequate methodologies to improve the effort inputs of the agent when looking at the principal agent theory through an employer vs employee level of conduct. On
3154-553: The basis of cost savings. This tendency is of course to some extent offset by the danger of retaliation and/or demotivation of the employee, if the supervisor is responsible for that employee's output. Another problem relates to what is known as the "compression of ratings". Two related influences—centrality bias, and leniency bias—have been documented (Landy and Farr 1980, Murphy and Cleveland 1991). The former results from supervisors being reluctant to distinguish critically between workers (perhaps for fear of destroying team spirit), while
3237-420: The broiler chicken industry (Knoeber and Thurman 1994), would take risky actions instead of increasing their effort supply as a cheap way to improve the prospects of winning. These actions are inefficient as they increase risk taking without increasing the average effort supplied. Neilson (2007) further added to this from his studies which indicated that when two employees competed to win in a tournament they have
3320-403: The compensation scheme becomes more like a call option on performance (which increases in value with increased volatility (cf. options pricing ). If you are one of ten players competing for the asymmetrically large top prize, you may benefit from reducing the expected value of your overall performance to the firm in order to increase your chance that you have an outstanding performance (and win
3403-409: The context of a dynamic multi-agent economic system. An economic model in which all agents of a given type (such as all consumers, or all firms) are assumed to be exactly identical is called a representative agent model. A model which recognizes differences among agents is called a heterogeneous agent model. Economists often use representative agent models when they want to describe the economy in
Principal–agent problem - Misplaced Pages Continue
3486-420: The context of energy consumption by Jaffe and Stavins in 1994. They were attempting to catalog market and non-market barriers to energy efficiency adoption. In efficiency terms, a market failure arises when a technology which is both cost-effective and saves energy is not implemented. Jaffe and Stavins describe the common case of the landlord-tenant problem with energy issues as a principal–agent problem. "[I]f
3569-415: The context of law, principals do not know enough about whether (or to what extent) a contract has been satisfied, and they end up with agency costs . The solution to this information problem—closely related to the moral hazard problem—is to ensure the provision of appropriate incentives so agents act in the way principals wish. In terms of game theory , it involves changing the rules of the game so that
3652-466: The cost of being underpaid when young. Salop and Salop (1976) argue that this derives from the need to attract workers more likely to stay at the firm for longer periods, since turnover is costly. Alternatively, delays in evaluating the performance of workers may lead to compensation being weighted to later periods, when better and poorer workers have to a greater extent been distinguished. (Workers may even prefer to have wages increasing over time, perhaps as
3735-486: The data correlated a spike in performance as a direct result. Conclusively, their studies indicated business owner (principal) and business employees (agents) must find a middle ground which coincides with an adequate shared profit for the company that is proportional to CEO pay and performance. In doing this risk aversion of employee efforts being low can be avoided pre-emptively. Milgrom and Roberts (1992) identify four principles of contract design: When perfect information
3818-429: The employer should be equally valuable (in terms of compensation, including non-financial aspects such as pleasantness of the workplace) to the employee. This relates to the problem that employees may be engaged in several activities, and if some of these are not monitored or are monitored less heavily, these will be neglected, as activities with higher marginal returns to the employee are favoured. This can be thought of as
3901-452: The employment contract, individual contracts form a major method of restructuring incentives, by connecting as closely as optimal the information available about employee performance, and the compensation for that performance. Because of differences in the quantity and quality of information available about the performance of individual employees, the ability of employees to bear risk, and the ability of employees to manipulate evaluation methods,
3984-560: The energy bills are paid by the landlord, leaving the tenant with no incentive to moderate her energy use. This is often the case for leased office space, for example. Agent (economics) For example, buyers ( consumers ) and sellers ( producers ) are two common types of agents in partial equilibrium models of a single market . Macroeconomic models , especially dynamic stochastic general equilibrium models that are explicitly based on microfoundations , often distinguish households , firms , and governments or central banks as
4067-485: The fact that they are characterized by "low skill levels, low earnings, easy entry, job impermanence, and low returns to education or experience." The informal economy consists of labour that is often "pay-under-the-table". This market tends to attract the poor and a disproportionate number of minority group members. The dual labour market theory generally ignores the micro-level decisions such as an individual’s cost-benefit analysis. Instead, it focuses on immigration as
4150-403: The fact that they are characterized by "low skill levels, low earnings, easy entry, job impermanence, and low returns to education or experience." In a number of service jobs, such as food service, golf caddying, and valet parking jobs, workers in some countries are paid mostly or entirely with tips . The use of tipping is a strategy on the part of the owners or managers to align the interests of
4233-410: The findings. Incentive structures as mentioned above can be provided through non-monetary recognition such as acknowledgements and compliments on an employee (agent) in place of employment. Research conducted by Crifo and Diaye (2004) mentioned that agents who receive compensations such as praises, acknowledgement and recognition help to define intrinsic motivations that increase performance output from
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#17327914030814316-474: The greatest appearance of being useful and constructive, and more generally to try to curry personal favour with supervisors. (One can interpret this as a destruction of organizational social capital —workers identifying with, and actively working for the benefit of, the firm – in favour of the creation of personal social capital—the individual-level social relations which enable workers to get ahead ("networking").) The four principles can be summarized in terms of
4399-411: The industry and take jobs that would better suit their personalities.'" As a solution to the principal–agent problem, though, tipping is not perfect. In the hopes of getting a larger tip, a server, for example, may be inclined to give a customer an extra large glass of wine or a second scoop of ice cream. While these larger servings make the customer happy and increase the likelihood of the server getting
4482-471: The landlord pays for the equipment and the tenant pays the energy bills, the investment in new, energy-efficient appliances will not be made. In this case, there is also little incentive for the tenant to make a capital efficiency investment with a usual payback time of several years, and which in the end will revert to the landlord as property. Since energy consumption is determined both by technology and by behavior, an opposite principal agent problem arises when
4565-414: The latter derives from supervisors being averse to offering poor ratings to subordinates, especially where these ratings are used to determine pay, not least because bad evaluations may be demotivating rather than motivating. However, these biases introduce noise into the relationship between pay and effort, reducing the incentive effect of performance-related pay. Milkovich and Wigdor (1991) suggest that this
4648-426: The linear incentive structures summarised in the model above. But while the combination of normal errors and the absence of income effects yields linear contracts, many observed contracts are nonlinear. To some extent this is due to income effects as workers rise up a tournament/hierarchy: "Quite simply, it may take more money to induce effort from the rich than from the less well off." (Prendergast 1999, 50). Similarly,
4731-462: The main types of agents in the economy. Each of these agents may play multiple roles in the economy; households, for example, might act as consumers, as workers , and as voters in the model. Some macroeconomic models distinguish even more types of agents, such as workers and shoppers or commercial banks . The term agent is also used in relation to principal–agent models; in this case, it refers specifically to someone delegated to act on behalf of
4814-456: The many specific measures available (e.g., number of home runs), but frequently receive bonuses for aggregate performance measures such as Most Valuable Player. The alternative to objective measures is subjective performance evaluation, typically by supervisors. However, there is here a similar effect to "multi-tasking", as workers shift effort from that subset of tasks which they consider useful and constructive, to that subset which they think gives
4897-465: The more visibly productive activities—Paul 1992), or by working "too hard" to signal worker quality or create a good impression (Holmström 1982); or by influencing the evaluation of it, e.g., by "currying influence" (Milgrom and Roberts 1988) or by outright bribery (Tirole 1992). Much of the discussion here has been in terms of individual pay-for-performance contracts; but many large firms use internal labour markets (Doeringer and Piore 1971, Rosen 1982) as
4980-496: The most general sense of the worker's input to the firm's production function), the more compensation varies with effort, the better the incentives for the worker to produce. The third principle—the Monitoring Intensity Principle— is complementary to the second, in that situations in which the optimal intensity of incentives is high corresponds highly to situations in which the optimal level of monitoring
5063-404: The most qualified person. This effectively takes the factors of ambiguity away from the principal agent problem by ensuring that the agent acts in the best interest of the principal but also ensures that the quality of work done is of an optimal level. Thirdly, where prize structures are (relatively) fixed, it reduces the possibility of the firm reneging on paying wages. As Carmichael (1983) notes,
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#17327914030815146-422: The point of view of the employer. The Incentive-Intensity Principle states that the optimal intensity of incentives depends on four factors: the incremental profits created by additional effort, the precision with which the desired activities are assessed, the agent's risk tolerance, and the agent's responsiveness to incentives. According to Prendergast (1999, 8), "the primary constraint on [performance-related pay]
5229-416: The potential adopter is not the party that pays the energy bill, then good information in the hands of the potential adopter may not be sufficient for optimal diffusion; adoption will only occur if the adopter can recover the investment from the party that enjoys the energy savings. Thus, if it is difficult for the possessor of information to convey it credibly to the party that benefits from reduced energy use,
5312-406: The principal are costly to the agent, and where elements of what the agent does are costly for the principal to observe. The agency problem can be intensified when an agent acts on behalf of multiple principals (see multiple principal problem ). When multiple principals have to agree on the agent's objectives, they face a collective action problem in governance, as individual principals may lobby
5395-435: The principal owns the firm as part of a diversified portfolio this may be a price worth paying for the greater chance of success through innovation elsewhere in the portfolio. If however the risks taken are systematic and cannot be diversified e.g., exposure to general housing prices, then such failures will damage the interests of principals and even the economy as a whole. (cf. Kidder Peabody , Barings , Enron , AIG to name
5478-405: The principal's interest by the agent is called " agency costs ". Common examples of this relationship include corporate management (agent) and shareholders (principal), elected officials (agent) and citizens (principal), or brokers (agent) and markets (buyers and sellers, principals). In all these cases, the principal has to be concerned with whether the agent is acting in the best interest of
5561-460: The principal. Principal-agent models typically either examine moral hazard (hidden actions) or adverse selection (hidden information). The principal–agent problem typically arises where the two parties have different interests and asymmetric information (the agent having more information), such that the principal cannot directly ensure that the agent is always acting in the principal's best interest, particularly when activities that are useful to
5644-473: The prize). In moderation this can offset the greater risk aversion of agents vs principals because their social capital is concentrated in their employer while in the case of public companies the principal typically owns its stake as part of a diversified portfolio. Successful innovation is particularly dependent on employees' willingness to take risks. In cases with extreme incentive intensity, this sort of behavior can create catastrophic organizational failure. If
5727-897: The product of g (the weight given to observed exogenous effects on outcomes) and y (observed exogenous effects on outcomes). b is the slope of the relationship between compensation and outcomes. wage = ( base salary ) + ( incentives ) ⋅ ( (unobserved) effort + (unobserved) effects + ( weight g ) ⋅ ( observed exogenous effects ) ) {\displaystyle {\begin{aligned}{\text{wage}}={}&({\text{base salary}})+({\text{incentives}})\cdot {\Big (}{\text{(unobserved) effort}}+{\text{(unobserved) effects}}\\[5pt]&{}+({\text{weight }}g)\cdot ({\text{observed exogenous effects}}){\Big )}\end{aligned}}} The above discussion on explicit measures assumed that contracts would create
5810-556: The same time, since equity may be seen as a call option on the value of the firm, an increase in the variance in the firm value, other things remaining equal, will lead to an increase in the value of equity, and stockholders may therefore take risky projects with negative net present values, which while making them better off, may make the bondholders worse off. See Option pricing approaches under Business valuation for further discussion. Nagel and Purnanandam (2017) notice that since bank assets are risky debt claims, bank equity resembles
5893-413: The segmented labour market) theory aims at introducing a broader range of factors into economic research, such as institutional aspects, race and gender. It divides the economy into two parts, called the "primary" and "secondary" sectors. The distinction may also be drawn between formal/informal sectors or sectors with high/low value-added. A broader concept is that of labour market segmentation . While
5976-406: The self-interested rational choices of the agent coincide with what the principal desires. Even in the limited arena of employment contracts, the difficulty of doing this in practice is reflected in a multitude of compensation mechanisms and supervisory schemes, as well as in critique of such mechanisms as e.g., Deming (1986) expresses in his Seven Deadly Diseases of management. In the context of
6059-461: The service workers with those of the owners or managers; the service workers have an incentive to provide good customer service (thus benefiting the company's business), because this makes it more likely that they will get a good tip. The issue of tipping is sometimes discussed in connection with the principal–agent theory. "Examples of principals and agents include bosses and employees ... [and] diners and waiters." "The "principal–agent problem", as it
6142-415: The simplest (linear) model of incentive compensation: w = a + b ( e + x + g y ) {\displaystyle w=a+b(e+x+gy)\,} where w (wage) is equal to a (the base salary) plus b (the intensity of incentives provided to the employee) times the sum of three terms: e (unobserved employee effort) plus x (unobserved exogenous effects on outcomes) plus
6225-522: The simplest terms possible. In contrast, they may be obliged to use heterogeneous agent models when differences among agents are directly relevant for the question at hand. For example, considering heterogeneity in age is likely to be necessary in a model used to study the economic effects of pensions; considering heterogeneity in wealth is likely to be necessary in a model used to study precautionary saving or redistributive taxation. Dual labour market The dual labour market (also referred to as
6308-412: The socio-cultural context they are embedded in ( Fukuyama 1995, Granovetter 1985), in order not to destroy the social capital they might more constructively mobilise towards building an organic, social organization, with the attendant benefits from such things as "worker loyalty and pride (...) [which] can be critical to a firm's success ..." (Sappington 1991,63) Subjective performance evaluation allows
6391-532: The structural details of individual contracts vary widely, including such mechanisms as "piece rates, [share] options, discretionary bonuses, promotions, profit sharing, efficiency wages, deferred compensation, and so on." Typically, these mechanisms are used in the context of different types of employment: salesmen often receive some or all of their remuneration as commission, production workers are usually paid an hourly wage, while office workers are typically paid monthly or semimonthly (and if paid overtime, typically at
6474-510: The task at hand is more repetitive, and reduces performance when the task at hand requires more creative thinking. Furthermore, formulated from their studies that compensation tend to have an impact on performance as a result of risk aversion and the level of work that a CEO is willing to input. This showed that when the CEO returned less effort then the data correlated a pay level of neutral aversion based on incentives. However, when offered incentives
6557-466: The tenant through the payment of rent? As Murtishaw and Sathaye, 2006 point out, "In the residential sector, the conceptual definition of principal and agent must be stretched beyond a strictly literal definition." Another distinction is that the principal agent problem in energy efficiency does not require any information asymmetry: both the landlord and the tenant may be aware of the overall costs and benefits of energy-efficient investments, but as long as
6640-495: The theory, with theorists Stephen Ross and Barry Mitnick both claiming authorship. Ross is said to have originally described the dilemma in terms of a person choosing a flavor of ice-cream for someone whose tastes they do not know ( Ibid ). The most cited reference to the theory, however, comes from Michael C. Jensen and William Meckling. The theory has come to extend well beyond economics or institutional studies to all contexts of information asymmetry , uncertainty and risk . In
6723-426: The threat of being fired creates a nonlinearity in wages earned versus performance. Moreover, many empirical studies illustrate inefficient behaviour arising from nonlinear objective performance measures, or measures over the course of a long period (e.g., a year), which create nonlinearities in time due to discounting behaviour. This inefficient behaviour arises because incentive structures are varying: for example, when
6806-541: The use of a subtler, more balanced assessment of employee performance, and is typically used for more complex jobs where comprehensive objective measures are difficult to specify and/or measure. Whilst often the only feasible method, the attendant problems with subjective performance evaluation have resulted in a variety of incentive structures and supervisory schemes. One problem, for example, is that supervisors may under-report performance in order to save on wages, if they are in some way residual claimants, or perhaps rewarded on
6889-575: The word "dual" implies a division into two parallel markets, segmentation in its broadest sense may involve several distinct labour markets. In a dual labour market, a secondary sector is characterized by short-term employment relationships, little or no prospect of internal promotion , and the determination of wages primarily by market forces. In terms of occupations, it consists primarily of low or unskilled jobs, whether they are blue-collar (manual labour), white-collar (e.g. filing clerks), or service industry (e.g. waiters). These jobs are linked by
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