| Abstract: |
We conduct laboratory experiments to investigate basic predictions of
principal-agent theory about the choice of piece rate contracts in the
presence of output risk, and provide novel insights that reference dependent
preferences affect the tradeoff between risk and incentives. Subjects in our
experiments choose their compensation for performing a real-effort task from a
menu of linear piece rate and fixed payment combinations. As classical
principal-agent models predict, more risk averse individuals choose lower
piece rates. However, in contrast to those predictions, we find that
low-productivity risk averse workers choose higher piece rates when the
riskiness of the environment increases. We hypothesize that reference points
affect piece rate choice in risky environments, such that individuals whose
expected earnings would exceed (fall below) the reference point in a risk-free
environment behave risk averse (seeking) in risky environments. In a second
experiment, we exogenously manipulate reference points and confirm this
hypothesis. |