Specific knowledge and performance measurement

Authors


  • I would like to thank two anonymous referees for many suggestions. I also received much useful feedback from Jim Brickley, Wouter Dessein, Guido Friebel, Luis Garicano, Limor Golan, Justin Johnson, Michal Matejka, Meg Meyer, Kevin J. Murphy, Oguzhan Ozbas, Canice Prendergast, Allison Raith, Marcelo Rezende, Andreas Roider, Steve Tadelis, Laurence van Lent, Mike Waldman, Joanna Wu, Jan Zabojnik, Jerry Zimmerman, and seminar participants at Cornell, Rochester, Toulouse, USC, Washington University St. Louis, and several conferences.

Abstract

I examine optimal incentives and performance measurement in a model where an agent has specific knowledge (in the sense of Jensen and Meckling) about the consequences of his actions for the principal. Contracts can be based both on “input” measures related to the agent's actions and an “output” measure related to the principal's payoff. Whereas input-based pay minimizes income risk, only output-based pay encourages the agent to use his knowledge efficiently. In general, it is optimal to use both kinds of performance measures. The results help to explain some empirical puzzles and lead to several new predictions.

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