Agency and Anxiety

32 Pages Posted: 30 Oct 2006 Last revised: 13 May 2014

See all articles by Michael T. Rauh

Michael T. Rauh

Indiana University - Kelley School of Business - Department of Business Economics & Public Policy

Giulio Seccia

University of Southampton - Division of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: July 2007

Abstract

In this paper, we introduce the psychological concept of anxiety into the standard linear agency model. After replacing the agent's risk premium with anxiety, we show that the agent's optimal effort can conform to the inverted-U hypothesis, which states that an increase in anxiety improves performance when anxiety is low, but reduces it when anxiety is high. It follows that high-powered incentives can backfire when they generate too much anxiety, in line with recent experimental evidence. A rational principal, however, never finds it optimal to offer such counterproductive incentives, which reconciles the seemingly contradictory empirical and experimental findings on the effects of incentives. Since anxiety can be motivational, the model explains violations of the Informativeness Principle where a principal injects noise into the contract or fails to filter it out. Finally, incentives and risk can be strategic complements for the principal with respect to generating effort, which can explain the mixed evidence for the risk-reward tradeoff.

Keywords: anxiety, incentives, informativeness principle, intrinsic motivation, risk-reward tradeoff

JEL Classification: M52, D86, L2

Suggested Citation

Rauh, Michael T. and Seccia, Giulio, Agency and Anxiety (July 2007). Available at SSRN: https://ssrn.com/abstract=940922 or http://dx.doi.org/10.2139/ssrn.940922

Michael T. Rauh (Contact Author)

Indiana University - Kelley School of Business - Department of Business Economics & Public Policy ( email )

Bloomington, IN 47405
United States

Giulio Seccia

University of Southampton - Division of Economics ( email )

Southampton, SO17 1BJ
United Kingdom
+44 23 8059 3529 (Phone)
+44 23 8059 3858 (Fax)

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