Incentives in Common Agency: An Experiment

Abstract: Title Incentives in a Common Agency: An Experiment Author Roy Forsberg Seminar date 2007-01-31 Tutors Dr. Fredrik Andersson and PhD Tommy Andersson Course Master Thesis in Economics – 10 Swedish credits (15 ECTS) Purpose Analyze the make-or-buy decision from a microeconomic perspective by combining modern common agency theory with the theory of incentives and game theory. From this I hope to convey two things. First I like to look at which contracts that can be establish when an agent is contracted by multiple competing principals. Secondly, I will try to identify their key properties and interpret their economic significance for firms buying part of their production or services from an independent entrepreneur. Research questions (i) Which contracts can be established? (ii) What are their key properties? Methodology The thesis is based on an experimental design constructed for the above stated purpose. All data is examined where an OLS regression constitute an important part. Conclusions This paper shows that if the cost of loosing a job is low and agents are paid a fixed wage shirking will occur. Thus, in a common agency situation where multiple principals are trying to influence a single agent and where hazardous behaviour cannot be punished it may be better to rely on bonus result contracts. Moreover it is shown that the decisive factor for allocating effort to a contract is the bonus rate and that wage has a very small influence on this decision, i.e. agents do respond to incentives. Finally it is shown that incentive pay serves not only to allocate risks and motivate hard work, it also serves to direct the allocation of the agents’ attention among the two different contracts, i.e. by increasing the incentive for just one task it is found that it causes an agent to devote to much time to this specific task and neglect other aspects of contracted job. Key words Incentive – Contract - Game theory – Make-or-Buy – Common Agency