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Limited liability and the risk–incentive relationship

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Abstract

Several empirical findings have challenged the traditional view on the trade-off between risk and incentives. By combining risk aversion and limited liability in a standard principal-agent model, the empirical puzzle on the positive relationship between risk and incentives can be explained. Increasing risk leads to a less informative performance signal. Under limited liability, the principal may optimally react by increasing the weight on the signal and, hence, choosing higher-powered incentives.

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  1. University of Bonn, Adenauerallee 24-42, 53113, Bonn, Germany

    Jörg Budde & Matthias Kräkel

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  1. Jörg Budde
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  2. Matthias Kräkel
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Correspondence to Jörg Budde.

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Budde, J., Kräkel, M. Limited liability and the risk–incentive relationship. J Econ 102, 97–110 (2011). https://doi.org/10.1007/s00712-010-0183-7

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  • DOI: https://doi.org/10.1007/s00712-010-0183-7

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