Gaming and Strategic Opacity in Incentive Provision

42 Pages Posted: 8 Jan 2013 Last revised: 11 Jun 2014

Florian Ederer

Yale University - School of Management; Yale University - Cowles Foundation

Richard Holden

University of Chicago

Margaret Meyer

University of Oxford - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: January 20, 2014

Abstract

It is often suggested that incentive schemes under moral hazard can be gamed by an agent with superior knowledge of the environment, and that deliberate lack of transparency about the incentive scheme can reduce gaming. We formally investigate these arguments in a two-task moral hazard model in which the agent is privately informed about which task is less costly for him to work on. We examine two simple classes of incentive scheme that are "opaque" in that they make the agent uncertain ex ante about the values of the incentive coefficients in the linear payment rule. We show that, relative to deterministic menus of linear contracts, these opaque schemes induce more balanced efforts, but they also impose more risk on the agent per unit of aggregate effort induced. We identify settings in which optimally designed opaque schemes not only strictly dominate the best deterministic menu but also completely eliminate the efficiency losses from the agent's better knowledge of the environment. Opaque schemes are more likely to be preferred to transparent ones when i) efforts on the tasks are highly complementary for the principal; ii) the agent's privately known preference between the tasks is weak; iii) the agent's risk aversion is significant; and iv) the errors in measuring performance on the tasks have large correlation or small variance.

Keywords: incentives, gaming, contracts, opacity

JEL Classification: D86, D21, L22

Suggested Citation

Ederer, Florian and Holden, Richard and Meyer, Margaret, Gaming and Strategic Opacity in Incentive Provision (January 20, 2014). UCLA School of Law, Law-Econ Research Paper No. 13-01. Available at SSRN: https://ssrn.com/abstract=2197597 or http://dx.doi.org/10.2139/ssrn.2197597

Florian Ederer (Contact Author)

Yale University - School of Management ( email )

165 Whitney Avenue
New Haven, CT 06511
United States

HOME PAGE: http://faculty.som.yale.edu/florianederer/

Yale University - Cowles Foundation ( email )

Box 208281
New Haven, CT 06520-8281
United States

Richard Holden

University of Chicago ( email )

1101 East 58th Street
Chicago, IL 60637
United States

Margaret A. Meyer

University of Oxford - Department of Economics ( email )

Manor Road Building
Manor Road
Oxford, OX1 3BJ
United Kingdom
44-1865-278-570 (Phone)
44-1865-278-557 (Fax)

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