Risk or Loss Aversion? Evidence from Personnel Records Emil P. Iantchev Syracuse University Econometric Society Meetings 21 June 2008

Outline Basic Idea Example This Paper Models of imperfect risk-sharing can be utilized to obtain novel information about attitudes towards risk Example Risk-sharing in the presence of moral hazard This Paper Derive optimal sharing rule: moral hazard, risk-neutral principal, loss-averse agent Estimate model parameters using micro data Risk or loss aversion? Goodness-of-fit simulations Emil P. Iantchev Risk or Loss Aversion?

Loss Aversion and Moral Hazard Static Principal-Agent Model S output levels-Y1<…<YS and two effort levels-H and L MLRC: PsH / PsL non-decreasing in s Output contractible, lower bound, wmin, on ex-post transfer to agent Principal risk-neutral Preferences of Agent v(w-r) +D(L)e r-reference transfer e-cost of high effort Strong Los Aversion: (v’ )-(0)/(v’ )+(0) > 1 and (v’ )(wmin-r)/(v’)+(0) > 1 Diminishing sensitivity: (v’’ )(x) < 0 for x > 0 (v’’ )(x) ≥ 0 for x < 0 Emil P. Iantchev Risk or Loss Aversion?

Optimal Sharing Rule Pros Cons Commonly observed in practice Figure: Transfer as a function of output Pros Commonly observed in practice Ties in termination as a disciplining device Cons What determines r? MLRC? Evidence of punishment? Improved model fit? Emil P. Iantchev Risk or Loss Aversion?

Estimating the Model Safelite Corp. Dataset [Lazear. (2000). AER] Table: Descriptive statistics Safelite Corp. Dataset [Lazear. (2000). AER] Switched workers from fixed wages to incentive pay (PPP) over the period Jan 94-Jun 95. Environment in company close to model assumptions Incentive contract adopted by Safelite—piece rate with a minimum guarantee—commonly used in practice Emil P. Iantchev Risk or Loss Aversion?

What Determines r ? Prevalent Contract in the Market C*=({b*s }s, a*) prevalent contract => r = E[b* |a*] Competitive Market No single principal can influence reference point by deviating Safelite Case Deviation by one principal from prevalent (fixed wage) contract. Agent reference point r = w = E[Y|L] in both regimes. Under PPP over 93 percent of Safelite employees given a guarantee precisely equal to their previous wage rate. Emil P. Iantchev Risk or Loss Aversion?

Estimating the Output Process Estimation and Simulation Samples ln[uadit]~ N(μit,σ2it) μit=βμ.effortit+δμ.Zit ln[σ2it]=βσ.effortit+δσ.Zit Pooled OLS adjusting for attrition (IPW) Table: Estimates of output parameters Note: Individual characteristics include job category, quadratic in tenure, and initial wage or hourly guarantee . Emil P. Iantchev Risk or Loss Aversion?

Punishment Region ? Discrete Hazard Model Table: Separation estimates, logistic hazard model Discrete Hazard Model sit = Pr(Ti =t |Ti ≥t, Xit ) Ti—i’s tenure with the firm Xit –observables, including current output realization Non-linear Relation between Output and Separations under PPP Split output distribution in 10 categorical variables Emil P. Iantchev Risk or Loss Aversion?

Estimating Preferences Table: GMM estimates of several preference models GMM Estimation Estimate Λ, γg , γl , wmin (Xit,ψ), e(Xit,ξ) via GMM on the incentive and participation constraints. Utility Function v(x) = x + γg.x2 for x > 0 Λx + γl.x2 else. Emil P. Iantchev Risk or Loss Aversion?

Goodness-of-fit Simulations Table: Assessing the goodness-of-fit for several preference specifications, simulation sample. Significant Cost Difference On average, the cost difference between M1 and M2 is about $650 per person-month. Emil P. Iantchev Risk or Loss Aversion?

Summary This Paper Risk or Loss Aversion? Derived optimal sharing rule: moral hazard, risk-neutral principal, loss-averse agent Estimated model parameters using micro data Assessed goodness-of-fit for various preference specifications Risk or Loss Aversion? Loss Aversion Reference dependence, loss aversion, and diminishing sensitivity provide greater flexibility in the local curvature of the utility function. Helps match better the non-linear features of observed sharing rules. Emil P. Iantchev Risk or Loss Aversion?