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Indiana University Bloomington

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1960 Notable

From 1960-2013, we prepared nearly 1,200 men and women
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Journal Articles

Agency and Anxiety

2010, Journal of Economics & Management Strategy

Michael T. Rauh, Giulio Seccia

Abstract

In this paper, we introduce the psychological concept of anxiety into agency theory. An important benchmark in the anxiety literature is the inverted-U hypothesis which states that an increase in anxiety improves performance when anxiety is low but reduces it when anxiety is high. We consider a version of the Holmstrom-Milgrom linear principal-agent model where the agent conforms to the inverted-U hypothesis and investigate the nature of the optimal linear contract. We find that although high-powered incentives can be demotivational, a profit-maximizing principal never offers them. In contrast, the principal may optimally engage in a demotivational level of monitoring. Moreover, since risk can be motivational, the principal may refrain from eliminating it even when monitoring is costless. Indeed, the principal may even add pure noise to the contract in order to motivate the agent, contradicting the informativeness principle. Finally, incentives and monitoring can be strategic substitutes or complements in our model.

Citation

Rauh, Michael T. and G. Seccia, "Agency and Anxiety'' Journal of Economics and Management Strategy, Vol. 19, Issue 1, (Spring 2010), pp. 87-116.