Gaming and Strategic Opacity in Incentive Provision

51 Pages Posted: 1 Feb 2013 Last revised: 25 Jun 2018

See all articles by Florian Ederer

Florian Ederer

Boston University - Markets, Public Policy, and Law; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI); Centre for Economic Policy Research (CEPR)

Richard Holden

University of New South Wales (UNSW)

Margaret A. Meyer

University of Oxford - Nuffield Department of Medicine

Multiple version iconThere are 2 versions of this paper

Date Written: January 2013

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 Classification: D21, D86, L22

Suggested Citation

Ederer, Florian and Holden, Richard and Meyer, Margaret A., Gaming and Strategic Opacity in Incentive Provision (January 2013). CEPR Discussion Paper No. DP9319, Available at SSRN: https://ssrn.com/abstract=2210290

Florian Ederer (Contact Author)

Boston University - Markets, Public Policy, and Law ( email )

Boston, MA
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
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1000 Brussels
Belgium

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Richard Holden

University of New South Wales (UNSW) ( email )

Kensington
High St
Sydney, NSW 2052
Australia

Margaret A. Meyer

University of Oxford - Nuffield Department of Medicine ( email )

New Road
Oxford, OX1 1NF
United Kingdom

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