Incentive schemes, moral hazard, and risk aversion: Intrafirm resource allocation and determinants of budgetary slack
AuthorBishop, Rachel Ann, 1957-
KeywordsBusiness Administration, Accounting.
AdvisorWaller, William S.
MetadataShow full item record
PublisherThe University of Arizona.
RightsCopyright © is held by the author. Digital access to this material is made possible by the University Libraries, University of Arizona. Further transmission, reproduction or presentation (such as public display or performance) of protected items is prohibited except with permission of the author.
AbstractThe existence of private information regarding expected productivity requires decentralized firms to develop intrafirm resource allocation mechanisms. Participation can help central management acquire and allocate resources according to divisional requirements. However, optimal plans require accurate pre-allocation communications. When preferences regarding local objectives, risk, and resources diverge, division managers may bias communications, creating budgetary slack. This study tested the effectiveness of unit-profit + penalty, firm-profit-sharing, and Groves incentive schemes in inducing truthful communication and controlling resource consumption under uncertainty. The experiment incorporated three independent variables: incentive scheme and utility for resource consumption were manipulated between-subjects; risk neutrality and risk aversion were induced within-subject. Three main results are presented. First, contrary to predictions, subjects do not misrepresent expected productivity more under risk aversion, regardless of scheme. Lack of support could be due to limited understanding regarding the experimental task and tradeoffs. The properties of the Groves scheme lead to an insufficient spread among its theoretical predictions, restricting the misrepresentation range and minimizing opportunities to observe differences. Second, both Groves and firm-profit-sharing groups consumed more resources than the unit-profit + penalty groups. Third, subjects in all groups exhibit significant increases in resource consumption under risk aversion. Increased consumption under risk aversion was predicted for both the Groves and firm-profit-sharing groups. However, decreased consumption was hypothesized for the unit-profit + penalty group. To contend with a difficult task under risk aversion and to increase the probability of winning when feedback indicated a low overall likelihood, subjects may have responded with "overconsumption strategies." Overall findings suggest that, although a unit-profit + penalty scheme does not appear to control misrepresentation better than either Groves or firm-profit-sharing schemes, it is more effective in controlling resource consumption. However, its effectiveness in controlling consumption diminishes with risk aversion.
Degree ProgramGraduate College