Rolls Royce Erp Implementation Essays

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American Economic Association

Incentives in Organizations Author(s): Robert Gibbons Source: The Journal of Economic Perspectives, Vol. 12, No. 4 (Autumn, 1998), pp. 115-132 Published by: American Economic Association Stable URL: Accessed: 26/03/2009 10:39
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By treating this model briefly, I do not mean to imply that the tradeoff between incentives and insurance is irrelevant, only that it is not nearly as central as it was once deemed.' In describing this and subsequent models, I omit some assumptions, derivations, and results; Prendergast (forthcoming) offers thorough introductions to many of these models. Consider an agent who takes an unobservable action a to produce output y. For example, the production function might be linear, y = a + s, where s is a noise term. The principal owns the output but contracts to share it with the agent by paying a wage w contingent on output. For example, the wage contract might be linear, w = s + by,where the intercept s is the salary and the slope b is the bonus rate. The agent's payoff is w - c(a), the realized wage minus the disutility of action c(a). The principal's payoff is y - w, the realized output net of wages. The key idea in this model is that the agent is risk-averse. (The principal may be as well.) A higher bonus rate b thus creates stronger incentives for the agent, but also imposes more risk on the agent. The extreme case of b = 0 offers the agent full insurance but creates no incentives; the other extreme, b = 1, gives the agent full title to the output y but offers the agent no insurance at all. The efficient bonus rate is between zero and one, depending on factors such
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