Managerial Incentives : On the Near Optimality of Linearity

Managers make efforts and choices. Efficient incentives to induce effort focus on the signal extraction problem of inferring the effort level. Efficient incentives for choices line up the relative payoffs of principal and agent. With choices much more important than the variation in the cost of inducing effort, the optimal payment schedule tends toward proportionality. The argument holds if the control space of the agent has full dimensionality, but not otherwise. If the agent's choices include a complete set of fair gambles and insurance, the proportional payoff schedule is no more expensive than any other schedule that induces effort. mi. 14 January 31, 1995 Managerial Incentives: On the Near Optimality of Linearity