1. 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
Industrial Economics
Flavio Pinto

2. 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

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

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

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

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

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

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

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

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

11. Competition and Managerial Compensation
Incentives to Managers
Management and Compensation

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

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

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