Optimal Common Contract with Heterogeneous Agents

We consider the principal-agent problem with heterogeneous agents. Previous works assume that the principal signs independent incentive contracts with every agent to make them invest more efforts on the tasks. However, in many circumstances, these contracts need to be identical for the sake of fairness. We investigate the optimal common contract problem. To our knowledge, this is the first attempt to consider this natural and important generalization. We first show this problem is NP-complete. Then we provide a dynamic programming algorithm to compute the optimal contract in $O(n^2m)$ time, where $n,m$ are the number of agents and actions, under the assumption that the agents' cost functions obey increasing difference property. At last, we generalize the setting such that each agent can choose to directly produce a reward in $[0,1]$. We provide an $O(\log n)$-approximate algorithm for this generalization

A Theoretical and Experimental Investigation of Efficiency, Equity, and Uncertainty in Tournaments

This dissertation consists of three essays centered around labor incentives that arise in relative compensation contracts. Chapter 1 poses the question: if devotion to a core competence were truly optimal, why would firms do otherwise? We argue that the behavior of drifting from the core may be motivated by the competitive incentives faced by managers who seek to rise within a firm. We find competition creates an incentive for a manager to look for less correlated opportunities that pull the firm in a new direction. In a symmetric equilibrium all managers behave this way, leading to lower expected output for the firm. A ?stick? that punishes the lowest performing manager in conjunction with a prize to the top performer can deter such behavior. Chapter 2 investigates how common shocks affect the behavior of heterogeneous agents in contracts designed to achieve both equity and efficiency. We show that when a procedurally fair and efficient tournament is desirable and compensates for heterogeneity, common shocks can bias the probability of winning of the agents. Also, the principal is found to have a commitment problem, favoring low risk agents to win, when fair and efficient tournaments are held between agents with different uncertainty distributions. Chapter 3 uses an experiment to examine issues of fairness and efficiency in rank-order tournaments with agents heterogeneous in abilities and random shock distributions. To study these issues, we observe agent effort, contract choice, and role choice from participating in three contracts that vary in perceptions of equal opportunity: equal access, equal expected earnings, and equal changes of winning. The primary result is that equal pay in the form of equal expected outcomes promotes efficiency and greater perceptions of fairness than does equal access to common contracts

Tournaments with Ex Post Heterogeneous Agents

This paper compares relative performance evaluation via tournaments to absolute performance evaluation via piece rates when agents are heterogeneous ex post, to make the point that agent heterogeneity compromises the insurance function of tournaments. In particular, we show that the more heterogeneous agents are the less insurance can be offered through tournaments and the less dominant tournaments are over piece rates. Thus, absolute performance piece rates should be preferred when agents are highly heterogeneous. However, even with heterogeneous agents, tournaments become more desirable when the number of agents or the uncertainty about the common shock increases sufficiently.piece rates

Exogenous Targeting Instruments with Heterogeneous Agents

This paper investigates the ability of ambient pollution instruments to induce a group of heterogeneous agents to choose a target outcome. Six controlled laboratory sessions were conducted with heterogeneous agents facing ambient pollution instruments with lump sum or proportional fines and bonuses. Sessions are compared with a study of these exogenous targeting instruments and homogenous agents using complete information and certainty [25]. The data show that contracts can indeed be developed that induce heterogeneous groups to choose the target outcome; however, substantial inefficiency and inequality were observed.

Pooling, Separating, and Cream-Skimming In Relative-Performance Contracts

Existing research on tournament-style contests suggests that mechanisms to sort contestants by ability level are unnecessary in the case of linear relative-performance contracts. This paper suggests that this result stems from uniform treatment of workers' marginal returns from effort, marginal disutilities of effort, and reservation wages. Here, we investigate relative-performance contracts with a model that allows these three factors to vary by growers' unobservable ability. Given this framework, we find that it is possible for processors to improve expected profits and total expected welfare by replacing a single contract offering meant to pool all growers with an offering of two contracts meant to separate growers by ability. Under some circumstances, a "cream-skimming" contract offering designed to attract only workers above a minimum ability level can also improve expected profits.Production Economics,

Discrimination and Strategic Group Division in Tournaments

The contracts we consider in this paper must solve three problems: moral hazard, insurance and discrimination. The moral hazard problem is that of providing the agents with incentives to perform in a way that maximizes the profit to the principal, when the agent's actions are unobservable. The insurance problem is that of minimizing the cost of risk through risk minimization and risk sharing. The issue of discrimination is that of paying agents with different skills sufficiently to participate, without overcompensating other agents. We show how the principal may benefit from a strategic division of the agents into different tournaments or groups. The optimal number of groups from the principal's point of view is determined through a trade-off between moral hazard, insurance and discrimination issues.Agribusiness,

Pooling, Separating, and Cream-Skimming In Relative-Performance Contracts

Existing research on tournament-style contests suggests that mechanisms to sort contestants by ability level are unnecessary in the case of linear relative-performance contracts. This paper suggests that this result stems from uniform treatment of workers' marginal returns from effort, marginal disutilities of effort, and reservation wages. Here, we investigate relative-performance contracts with a model that allows these three factors to vary by growers' unobservable ability. Given this framework, we find that it is possible for processors to improve expected profits and total expected welfare by replacing a single contract offering meant to pool all growers with an offering of two contracts meant to separate growers by ability. Under some circumstances, a 'cream-skimming' contract offering designed to attract only workers above a minimum ability level can also improve expected profits.Labor and Human Capital,

Differences in Social Preferences - Are They Profitable for the Firm?

This paper analyzes the impact of heterogeneous (social) preferences on the weighting and combination of performance measures as well as on a firm’s profitability. We consider rivalry, egoism and altruism as extreme forms within the continuum of possible preferences and show that the principal can typically exploit both the altruistic and rivalistic behavior of his agents. Firm profits reach their maximum value if the agents are differentiated as much as possible in their individual characteristics. We provide further insight; namely, that in order to realize these gains in profitability, it is necessary to reallocate participation in performance measures such that competitive agents are privileged as compared to altruistic agents. In this context, stochastic interdependencies are of importance since they yield overlapping functions of the share parameters, causing additional adaptations in the optimal design of the wage compensation system

Adverse Selection in an Efficiency Wage Model with Heterogeneous Agents

This paper studies efficiency wages in the presence of heterogeneous workers and asymmetric information. It includes an incentive compatibility constraint (ICC) in the efficiency wage model with heterogeneous workers to show that the implementation of efficiency wages in the presence of heterogeneity faces the problem of adverse selection. Employees with a smaller effort aversion supply a smaller level of effort than what is optimal under perfect information due to hidden information. In this vein only a second best solution is obtained.Efficiency Wages, Adverse Selection, Asymmetric Information