de Meza, David 
ORCID: 0000-0002-5638-8310 and Webb, David C. ORCID: 0009-0005-5611-7253
(2006)
Incentive design under loss aversion.
Financial Markets Group Discussion Papers (571).
Financial Markets Group, The London School of Economics and Political Science, London, UK.
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Abstract
Compensation schemes often reward success but do not penalize failure. Fixed salaries with stock options or bonuses have this feature. Yet the standard principal–agent model implies that pay is normally monotonically increasing in performance. This paper shows that, under loss aversion, there will be intervals over which pay is insensitive to performance, with the use of carrots but not sticks is frequently optimal, especially when risk aversion is low and reference income is endogenous. A further benefit of capping losses, for example through options, is to discourage reckless behavior by executives seeking to resurrect their fortunes.
| Item Type: | Monograph (Discussion Paper) |
|---|---|
| Official URL: | http://fmg.ac.uk |
| Additional Information: | © 2006 The Authors |
| Divisions: | Financial Markets Group |
| Subjects: | H Social Sciences > HG Finance H Social Sciences > HB Economic Theory |
| JEL classification: | F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance F - International Economics > F3 - International Finance |
| Date Deposited: | 19 Jul 2009 18:51 |
| Last Modified: | 11 Dec 2024 18:45 |
| URI: | http://eprints.lse.ac.uk/id/eprint/24523 |
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