Efficiency wages and executive compensation : the participation constraint in a principal-agent problem

Date
1992
Authors
Krulce, Darrell L.
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Abstract
The participation constraint in a principal-agent problem requires that an agent receive at least the reservation utility. A binding participation constraint means that the agent receives exactly the reservation utility whereas a non-binding participation constraint means that the agent receives more than the reservation utility. This dissertation examines the conditions which result in a binding or non-binding participation constraint. Analysis shows that if the agent exhibits non-increasing risk aversion towards action, then the participation constraint will always be binding. Computer simulation shows further that even if this condition does not hold, a binding participation constraint prevails, occurring more than 96% of the time for a wide variation of parameters. These results have two significant implications. First, the shirking model of efficiency wage theory depends critically on a non-binding participation constraint. That is, an efficient wage higher than the market wage implies that the participation constraint is non-binding. The result that a binding participation constraint generally prevails thus casts doubt on the microeconomic validity of the shirking model of efficiency wage theory. Second, when providing incentive pay for executives, a nonbinding participation constraint can be interpreted as executive overcompensation. The results suggest that compensation schemes exist which can elicit optimal behavior from executives without awarding excess pay. That is, there are compensation schemes which can eliminate excess executive compensation without loss of performance.
Description
Thesis (Ph. D.)--University of Hawaii at Manoa, 1992.
Includes bibliographical references (leaves 100-107)
Microfiche.
vii, 107 leaves, bound ill. 29 cm
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