Incentives: The Principal – Agent Problem Class 2 Ref: Monitoring, Management, Compensation, and Regulation. Chapter 15. Industrial Organization - Theory and Applications. Oz Shy. MIT Press. Pp. 395-420 Industrial Economics Flavio Pinto

Contents Questions: The Principal Agent Problem What motivates workers to work? How to motivate workers to work? The Principal Agent Problem Definition Providing Incentives under Certainty Providing Incentives under Uncertainty Incentives under Asymmetric Information Competition and Managerial Compensation Incentives to Managers Why Executives Are Paid More than Workers Contents

The Principal Agent Problem The Problem: Manager Supervisor Worker Supervised Example   H works hard Rest. Owner Waiter shirks  L The P-A Problem

The Principal Agent Problem Timing O W W a contract Design Participate Effort  ( ) UL  L       H UH ( ) The P-A Problem

Providing Incentives under Certainty The Worker: The Restaurant’ Owner The P-A Problem

Providing Incentives under Certainty The Contract: Participation Constraint: Incentive Constraint: The Contract The P-A Problem

Providing Incentives under Uncertainty The Influence of External Events out of Control: The P-A Problem

Providing Incentives under Uncertainty The Contract: Participation Constraint: Incentive Constraint: The Contract The P-A Problem

Providing Incentives under Uncertainty: Asymmetric Information Risk Aversion: The P-A Problem

Providing Incentives under Uncertainty The Contract: Participation Constraint: Incentive Constraint: The Contract WH WL The P-A Problem

Competition and Managerial Compensation Incentives to Managers Management and Compensation

Competition and Managerial Compensation A Two-Stages Decision Level Market Game Management and Compensation

Competition and Managerial Compensation A Two-Stages Decision Level Market Game qi qj Management and Compensation

Competition and Managerial Compensation Why Executives Are Paid More than Workers Management and Compensation