Common Shocks and Relative Compensation Schemes

13 Pages Posted: 4 May 2005

See all articles by Michael J. P. Magill

Michael J. P. Magill

University of Southern California - Department of Economics

Martine Quinzii

University of California, Davis - Department of Economics

Date Written: December 2004

Abstract

This paper studies qualitative properties of an optimal contract in a multi-agent setting in which agents are subject to a common shock. We derive a necessary and sufficient condition for the optimal reward of an agent producing an output level y to be a decreasing (increasing) function of the outputs of the other agents, under the assumption that the agents' outputs are informative signals of the value of the common shock. The condition is that the likelihood ratio p(y, e, n)/p(y, e', n), where e is a higher effort level than e', and n is the value of the common shock, be a decreasing (increasing) function of n. We derive conditions on the way the common shock affects the marginal product of effort under which the likelihood ratio is decreasing for all output levels, or increasing for some output levels and decreasing for others.

Suggested Citation

Magill, Michael J. P. and Quinzii, Martine, Common Shocks and Relative Compensation Schemes (December 2004). IEPR Working Paper No. 05-21. Available at SSRN: https://ssrn.com/abstract=716443 or http://dx.doi.org/10.2139/ssrn.716443

Michael J. P. Magill (Contact Author)

University of Southern California - Department of Economics ( email )

3620 South Vermont Ave. Kaprielian (KAP) Hall, 300
Los Angeles, CA 90089
United States
213-740-2104 (Phone)
213-740-8543 (Fax)

Martine Quinzii

University of California, Davis - Department of Economics ( email )

One Shields Drive
Davis, CA 95616-8578
United States
530-752-1567 (Phone)
530-752-9382 (Fax)

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