It is often impossible for a principal to observe accurately the contribution of an agent to firm output.

It is often impossible for a principal to observe accurately the contribution of an agent to firm output. In those cases, principals often substitute a proxy, p, for y in the generalized “sharecropping” compensation model. This makes the new expected total wage E(w) seen by the agent E(w) = s + bp. What statements about these types of incentive contracts are true?

a) They are almost always less “efficient” than y-based contracts and their efficiency depends on the correlation and scale of p relative to y.

b) They may promote inadvertent consequences (“you get what you pay for”)

c) Both (a) and (b)

d) None of the above

 
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