Working Paper: CEPR ID: DP9319
Authors: Florian Ederer; Richard Holden; Margaret A. Meyer
Abstract: It is often suggested that incentive schemes under moral hazard can be gamed by an agent with superior knowledge of the environment and that deliberate lack of transparency about the incentive scheme can reduce gaming. We formally investigate these arguments in a two-task moral hazard model in which the agent is privately informed about which task is less costly for him. We examine a simple class of incentive schemes that are "opaque" in that they make the agent uncertain ex ante about the incentive coefficients in the linear payment rule. Relative to transparent menus of linear contracts, these opaque schemes induce more balanced efforts, but they also impose more risk on the agent per unit of aggregate effort induced. We identify specific settings in which optimally designed opaque schemes not only strictly dominate the best transparent menu but also eliminate the efficiency losses from the agent's hidden information. Opaque schemes are more likely to be preferred to transparent ones when (i) the agent's privately known preference between the tasks is weak; (ii) the agent's risk aversion is significant; (iii) efforts on the tasks are highly complementary for the principal; or (iv) the errors in measuring performance have large correlation or small variance.
Keywords: contracts; gaming; incentives; opacity; randomization
JEL Codes: D86; D21; L22
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| opaque incentive schemes (D82) | reduce gaming (C73) |
| reduce gaming (C73) | balanced effort allocations (D51) |
| agent's private knowledge about task costs (D82) | effort choices (D87) |
| opaque schemes dominate transparent ones (Y10) | when agent's preference for tasks is weak (J29) |
| opaque schemes dominate transparent ones (Y10) | when risk aversion is significant (D81) |
| opaque schemes dominate transparent ones (Y10) | when efforts on tasks are complementary (D10) |
| optimally designed opaque schemes (D82) | eliminate efficiency losses associated with hidden information (D83) |
| opaque contracts (D86) | higher payoffs for principals compared to transparent contracts (D86) |