On the Preferences of Principals and Agents

17 Pages Posted: 16 Jun 2008

See all articles by Marco Castillo

Marco Castillo

Texas A&M University

Ragan Petrie

Texas A&M University - Department of Economics; University of Melbourne - Melbourne Institute of Applied Economic and Social Research

Maximo Torero

International Food Policy Research Institute (IFPRI)

Date Written: December 2007

Abstract

One of the reasons why market economies are able to thrive is that they exploit the willingness of entrepreneurs to take risks that laborers might prefer to avoid. Markets work because they remunerate good judgement and punish mistakes. Indeed, modern contract theory is based on the assumption that principals are less risk averse than agents. We investigate if the risk preferences of entrepreneurs are different from those of laborers by implementing experiments with a random sample of the population in a fast-growing, small-manufacturing, economic cluster. As assumed by theory, we find that entrepreneurs are more likely to take risks than hired managers. These results are robust to the inclusion of a series of controls. This lends support to the idea that risk preferences are an important determinant of selection into occupations. Finally, our lotteries are good predictors of financial decisions, thus giving support to the external validity of our risk measures and experimental methods.

Keywords: risk preferences, contract theory, entrepreneurs

JEL Classification: C93, D81, L21

Suggested Citation

Castillo, Marco and Petrie, Ragan and Torero, Maximo, On the Preferences of Principals and Agents (December 2007). Economic Inquiry, 2008. Available at SSRN: https://ssrn.com/abstract=1144718 or http://dx.doi.org/10.2139/ssrn.1144718

Marco Castillo (Contact Author)

Texas A&M University ( email )

5201 University Blvd.
College Station, TX 77843-4228
United States

HOME PAGE: http://www.marcocastillo.org

Ragan Petrie

Texas A&M University - Department of Economics ( email )

4228 TAMU
College Station, TX 77843-4228
United States

University of Melbourne - Melbourne Institute of Applied Economic and Social Research ( email )

Level 5, FBE Building, 111 Barry Street
Parkville, Victoria 3010
Australia

Maximo Torero

International Food Policy Research Institute (IFPRI) ( email )

1201 Eye St, NW,
Washington, DC 20005
United States

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