The existing empirical evidence is somewhat inconclusive with respect to a number of the key predictions of the agency model. Although the reach of agency theory is considerably wider, the dominant portion of work has been taken up with examining the nature of the trade-off between risk and incentives, and the implications thereof for contractual design. More specifically, some researchers have recently noted that the predicted trade-off between risk and incentives turns out to be rather weak, and perhaps non-existent, when confronted with the available empirical evidence. In this paper, we examine the risk-incentives trade-off and related predictions from agency theory on the basis of data from a data set encompassing close to 1000 Danish firms. We find that the relation between the use of performance pay in these firms and the environmental uncertainty they confront - which is one way to test the risk/incentives tradeoff - is indeed weak and in many cases even perverse. We then suggest, in line with other recent contributions to the literature, that this may be caused by the widespread use of delegation. One effect of delegation is that it breaks the simple relation between risks and incentives. We examine the suggestion that that those firms that are more prone to use delegation of decision rights in their internal organization are facing an uncertain environment to a larger extent than the rest of the population. We argue that this constitutes an indirect confirmation of the hypothesis. We also examine the multi-tasking agency hypothesis that as risk increases, the flexibility of agents is restricted. We fail to find support for this hypothesis. It is suggested that the reason for this finding is also related to delegation.
|DRUID - Danish Research Unit for Industrial Dynamics
|Udgivet - 2002
|DRUID Working Paper