Screening Versus Sorting in a Principal-Agent Model with Moral Hazard and Adverse Selection
58 Pages Posted: 16 Aug 2010
There are 2 versions of this paper
Screening Versus Sorting in a Principal-Agent Model with Moral Hazard and Adverse Selection
Screening Versus Sorting in a Principal-Agent Model with Moral Hazard and Adverse Selection
Date Written: August 16, 2010
Abstract
This paper proposes a principal-agent model of moral hazard and adverse selection that introduces the notion of screening, which is distinct from sorting; and distinguishes between ability that is privately known by the agent versus general ability that is observable by the principal and market. Sorting is the traditional process by which the adverse selection problem is resolved. Screening is the process we propose by which agents that are deemed to be unsuitable are rejected. Used in conjunction with sorting, we consider ex-ante screening on the basis of the (observable) measure of general ability; and ex-post screening on the basis of the private measure of ability. We identify the benefits and costs incurred by the principal associated with hiring an agent with superior ability, and derive the manner in which the compensation mechanism should be adjusted to take into account the roles of screening. The principal may prefer agents with inferior qualifications, rejecting those who are “overqualified”; conversely, she may select an agent with a distinguished pedigree, rejecting agents who are “underqualified”. Screening alters the relationship between the compensation mechanism and the characteristics of the agency relationship, causing established results to change, such as the negative link between risk and incentives. The empirical ramifications of screening are important: not controlling for screening introduces bias and inconsistency in estimation.
JEL Classification: M41
Suggested Citation: Suggested Citation
Do you have negative results from your research you’d like to share?
Recommended Papers
-
Are CEOS Really Paid Like Bureaucrats?
By Brian J. Hall and Jeffrey B. Liebman
-
Are CEOS Really Paid Like Bureaucrats?
By Brian J. Hall and Jeffrey B. Liebman
-
The Other Side of the Tradeoff: The Impact of Risk on Executive Compensation
-
Good Timing: CEO Stock Option Awards and Company News Announcements
-
Good Timing: CEO Stock Option Awards and Company News Announcements
-
The Use of Equity Grants to Manage Optimal Equity Incentive Levels
By John E. Core and Wayne R. Guay
-
The Other Side of the Tradeoff: the Impact of Risk on Executive Compensation
-
Stock Options for Undiversified Executives
By Brian J. Hall and Kevin J. Murphy