An Empirical Analysis of Risk, Incentives, and the Delegation of Worker Authority

Abstract

[Excerpt] The notion of a negative relationship between risk and incentives is a central prediction of agency theory. A vast literature has failed to find consistent empirical support for this prediction, with some studies finding a positive relationship, some a negative relationship, and some no relationship at all. Prendergast’s (2002) theory extends the principal-agent model to incorporate the delegation of worker authority, showing that a positive relationship between risk and incentives can arise and potentially explaining the mixed results from empirical tests. In this paper, we empirically test Prendergast’s theory. Using a large, nationally-representative cross section of British establishments that includes information both from employers and from multiple workers in each establishment, we address four empirical questions: 1) Is there evidence of a risk-incentives tradeoff as predicted by the principal-agent model? 2) Is there evidence of a positive relationship between incentive pay and the delegation of worker authority as assumed by Prendergast? 3) Is there evidence of a positive relationship between risk and authority as Prendergast also assumes? 4) Is there empirical support for the main testable implication of Prendergast’s model, namely that the evidence favoring a risk-incentives tradeoff should strengthen when authority controls are added to the model? Our answers are affirmative for all four questions.