IDEAS home Printed from https://ideas.repec.org/p/hrv/hksfac/9946786.html
   My bibliography  Save this paper

Solomonic Separation: Risk Decisions as Productivity Indicators

Author

Listed:
  • Miller, Nolan
  • Wagner, Alexander Florian
  • Zeckhauser, Richard Jay

Abstract

A principal provides budgets to agents (e.g., divisions of a firm or the principal's children) whose expenditures provide her benefits, either materially or because of altruism. Only agents know their potential to generate benefits. We prove that if the more "productive" agents are also more risk-tolerant (as holds in the sample of individuals we surveyed), the principal can screen agents and bolster target efficiency by offering a choice between a nonrandom budget and a two-outcome risky budget. When, at very low allocations, the ratio of the more risk-averse type's marginal utility to that of the other type is unbounded above (e.g., as with CRRA), the first-best is approached. A biblical opening enlivens the analysis.

Suggested Citation

  • Miller, Nolan & Wagner, Alexander Florian & Zeckhauser, Richard Jay, 2012. "Solomonic Separation: Risk Decisions as Productivity Indicators," Scholarly Articles 9946786, Harvard Kennedy School of Government.
    • Handle: RePEc:hrv:hksfac:9946786
    as

    Download full text from publisher

    File URL: http://dash.harvard.edu/bitstream/handle/1/9946786/RWP12-57_Zeckhauser.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Thomas Dohmen & Armin Falk & David Huffman & Uwe Sunde, 2010. "Are Risk Aversion and Impatience Related to Cognitive Ability?," American Economic Review, American Economic Association, vol. 100(3), pages 1238-1260, June.
    2. John Hey & Andrea Morone & Ulrich Schmidt, 2009. "Noise and bias in eliciting preferences," Journal of Risk and Uncertainty, Springer, vol. 39(3), pages 213-235, December.
    3. Donkers, Bas & Melenberg, Bertrand & Van Soest, Arthur, 2001. "Estimating Risk Attitudes Using Lotteries: A Large Sample Approach," Journal of Risk and Uncertainty, Springer, vol. 22(2), pages 165-195, March.
    4. Stein, Jeremy C, 1997. "Internal Capital Markets and the Competition for Corporate Resources," Journal of Finance, American Finance Association, vol. 52(1), pages 111-133, March.
    5. Richard Arnott & Joseph E. Stiglitz, 1988. "Randomization with Asymmetric Information," RAND Journal of Economics, The RAND Corporation, vol. 19(3), pages 344-362, Autumn.
    6. Lisa Anderson & Jennifer Mellor, 2009. "Are risk preferences stable? Comparing an experimental measure with a validated survey-based measure," Journal of Risk and Uncertainty, Springer, vol. 39(2), pages 137-160, October.
    7. Liqun Liu & Jack Meyer, 2012. "Decreasing absolute risk aversion, prudence and increased downside risk aversion," Journal of Risk and Uncertainty, Springer, vol. 44(3), pages 243-260, June.
    8. Mankiw, N. Gregory & Zeldes, Stephen P., 1991. "The consumption of stockholders and nonstockholders," Journal of Financial Economics, Elsevier, vol. 29(1), pages 97-112, March.
    9. Wakker, Peter P & Thaler, Richard H & Tversky, Amos, 1997. "Probabilistic Insurance," Journal of Risk and Uncertainty, Springer, vol. 15(1), pages 7-28, October.
    10. Brito, Dagobert L. & Hamilton, Jonathan H. & Slutsky, Steven M. & Stiglitz, Joseph E., 1995. "Randomization in optimal income tax schedules," Journal of Public Economics, Elsevier, vol. 56(2), pages 189-223, February.
    11. Matthew Rabin, 2000. "Risk Aversion and Expected-Utility Theory: A Calibration Theorem," Econometrica, Econometric Society, vol. 68(5), pages 1281-1292, September.
    12. W. Henry Chiu, 2005. "Skewness Preference, Risk Aversion, and the Precedence Relations on Stochastic Changes," Management Science, INFORMS, vol. 51(12), pages 1816-1828, December.
    13. Weiss, Laurence, 1976. "The Desirability of Cheating Incentives and Randomness in the Optimal Income Tax," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1343-1352, December.
    14. Leland, Hayne E & Pyle, David H, 1977. "Informational Asymmetries, Financial Structure, and Financial Intermediation," Journal of Finance, American Finance Association, vol. 32(2), pages 371-387, May.
    15. M. Harris & C. H. Kriebel & A. Raviv, 1982. "Asymmetric Information, Incentives and Intrafirm Resource Allocation," Management Science, INFORMS, vol. 28(6), pages 604-620, June.
    16. Harris Milton & Townsend, Robert M, 1981. "Resource Allocation under Asymmetric Information," Econometrica, Econometric Society, vol. 49(1), pages 33-64, January.
    17. Steven J. Brams & D. Marc Kilgour, 2001. "Competitive Fair Division," Journal of Political Economy, University of Chicago Press, vol. 109(2), pages 418-443, April.
    18. W Henry Chiu, 2010. "Skewness Preference, Risk Taking and Expected Utility Maximisation," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 35(2), pages 108-129, December.
    19. Hellwig, Martin F., 2007. "The undesirability of randomized income taxation under decreasing risk aversion," Journal of Public Economics, Elsevier, vol. 91(3-4), pages 791-816, April.
    20. Stiglitz, Joseph E., 1982. "Self-selection and Pareto efficient taxation," Journal of Public Economics, Elsevier, vol. 17(2), pages 213-240, March.
    21. John Winsor Pratt & Richard Jay Zeckhauser, 1990. "The Fair and Efficient Division of the Winsor Family Silver," Management Science, INFORMS, vol. 36(11), pages 1293-1301, November.
    22. Bernardo, Antonio E. & Cai, Hongbin & Luo, Jiang, 2001. "Capital budgeting and compensation with asymmetric information and moral hazard," Journal of Financial Economics, Elsevier, vol. 61(3), pages 311-344, September.
    23. Joseph Golec & Maurry Tamarkin, 1998. "Bettors Love Skewness, Not Risk, at the Horse Track," Journal of Political Economy, University of Chicago Press, vol. 106(1), pages 205-225, February.
    24. Robert B. Barsky & F. Thomas Juster & Miles S. Kimball & Matthew D. Shapiro, 1997. "Preference Parameters and Behavioral Heterogeneity: An Experimental Approach in the Health and Retirement Study," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 112(2), pages 537-579.
    25. Donald Meyer & Jack Meyer, 2005. "Relative Risk Aversion: What Do We Know?," Journal of Risk and Uncertainty, Springer, vol. 31(3), pages 243-262, December.
    26. Meyer, Jack, 1987. "Two-moment Decision Models and Expected Utility Maximization," American Economic Review, American Economic Association, vol. 77(3), pages 421-430, June.
    27. Antonio E. Bernardo, 2004. "Capital Budgeting in Multidivision Firms: Information, Agency, and Incentives," The Review of Financial Studies, Society for Financial Studies, vol. 17(3), pages 739-767.
    28. Rick Antle & Gary D. Eppen, 1985. "Capital Rationing and Organizational Slack in Capital Budgeting," Management Science, INFORMS, vol. 31(2), pages 163-174, February.
    29. Mark Grinblatt & Matti Keloharju & Juhani Linnainmaa, 2011. "IQ and Stock Market Participation," Journal of Finance, American Finance Association, vol. 66(6), pages 2121-2164, December.
    30. George A. Akerlof, 1970. "The Market for "Lemons": Quality Uncertainty and the Market Mechanism," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 84(3), pages 488-500.
    31. Chetan Dave & Catherine Eckel & Cathleen Johnson & Christian Rojas, 2010. "Eliciting risk preferences: When is simple better?," Journal of Risk and Uncertainty, Springer, vol. 41(3), pages 219-243, December.
    32. Harris, Milton & Raviv, Artur, 1996. "The Capital Budgeting Process: Incentives and Information," Journal of Finance, American Finance Association, vol. 51(4), pages 1139-1174, September.
    33. Nolan H. Miller & Nikita E. Piankov & Richard J. Zeckhauser, 2006. "Possibly‐Final Offers," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 15(3), pages 789-819, September.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Richard Langlois, 2013. "The Institutional Revolution: A review essay," The Review of Austrian Economics, Springer;Society for the Development of Austrian Economics, vol. 26(4), pages 383-395, December.
    2. Gibson Brandon, Rajna & Wagner, Alexander F. & Tanner, Carmen, 2014. "How effective are social norm interventions? Evidence from a laboratory experiment on managerial honesty," CEPR Discussion Papers 9880, C.E.P.R. Discussion Papers.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Hoang, Daniel & Gatzer, Sebastian & Ruckes, Martin E., 2018. "The economics of capital allocation in firms: Evidence from internal capital markets," Working Paper Series in Economics 115, Karlsruhe Institute of Technology (KIT), Department of Economics and Management.
    2. Sandro Brusco & Fausto Panunzi, 2020. "Internal financing, managerial compensation and multiple tasks," Annals of Finance, Springer, vol. 16(4), pages 501-527, December.
    3. García, Diego, 2014. "Optimal contracts with privately informed agents and active principals," Journal of Corporate Finance, Elsevier, vol. 29(C), pages 695-709.
    4. Gauthier, Stéphane & Laroque, Guy, 2014. "On the value of randomization," Journal of Economic Theory, Elsevier, vol. 151(C), pages 493-507.
    5. repec:cup:judgdm:v:14:y:2019:i:3:p:234-279 is not listed on IDEAS
    6. Stoughton, Neal M. & Zechner, Josef, 2007. "Optimal capital allocation using RAROC(TM) and EVA(R)," Journal of Financial Intermediation, Elsevier, vol. 16(3), pages 312-342, July.
    7. Jan-Erik Loennqvist & Markku Verkasalo & Gari Walkowitz & Philipp C. Wichardt, 2011. "Measuring Individual Risk Attitudes in the Lab: Task or Ask? An Empirical Comparison," Cologne Graduate School Working Paper Series 02-03, Cologne Graduate School in Management, Economics and Social Sciences.
    8. Wagner, Alexander F. & Miller, Nolan H. & Zeckhauser, Richard J., 2006. "Screening budgets," Journal of Economic Behavior & Organization, Elsevier, vol. 61(3), pages 351-374, November.
    9. Schmidbauer, Eric, 2019. "Budget selection when agents compete," Journal of Economic Behavior & Organization, Elsevier, vol. 158(C), pages 255-268.
    10. Holzmeister, Felix & Stefan, Matthias, 2019. "The Risk Elicitation Puzzle Revisited: Across-Methods (In)consistency?," OSF Preprints pj9u2, Center for Open Science.
    11. Lönnqvist, Jan-Erik & Verkasalo, Markku & Walkowitz, Gari & Wichardt, Philipp C., 2015. "Measuring individual risk attitudes in the lab: Task or ask? An empirical comparison," Journal of Economic Behavior & Organization, Elsevier, vol. 119(C), pages 254-266.
    12. Cremers, M. & Huang, R. & Sautner, Z., 2009. "Understanding Internal Capital Markets and Corporate Policies," Discussion Paper 2009-47 S, Tilburg University, Center for Economic Research.
    13. Felix Holzmeister & Matthias Stefan, 2019. "The risk elicitation puzzle revisited: Across-methods (in)consistency?," Working Papers 2019-19, Faculty of Economics and Statistics, Universität Innsbruck.
    14. Guiso, Luigi & Sodini, Paolo, 2013. "Household Finance: An Emerging Field," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, volume 2, chapter 0, pages 1397-1532, Elsevier.
    15. Roper, Andrew H. & Ruckes, Martin E., 2012. "Intertemporal capital budgeting," Journal of Banking & Finance, Elsevier, vol. 36(9), pages 2543-2551.
    16. Laux, Volker, 2008. "On the value of influence activities for capital budgeting," Journal of Economic Behavior & Organization, Elsevier, vol. 65(3-4), pages 625-635, March.
    17. Kim, Doyoung, 2006. "Capital budgeting for new projects: On the role of auditing in information acquisition," Journal of Accounting and Economics, Elsevier, vol. 41(3), pages 257-270, September.
    18. Lau Lilleholt, 2019. "Cognitive ability and risk aversion: A systematic review and meta analysis," Judgment and Decision Making, Society for Judgment and Decision Making, vol. 14(3), pages 234-279, May.
    19. Jonathan P. Beauchamp & David Cesarini & Magnus Johannesson, 2017. "The psychometric and empirical properties of measures of risk preferences," Journal of Risk and Uncertainty, Springer, vol. 54(3), pages 203-237, June.
    20. Galizzi, Matteo M. & Machado, Sara R. & Miniaci, Raffaele, 2016. "Temporal stability, cross-validity, and external validity of risk preferences measures: experimental evidence from a UK representative sample," LSE Research Online Documents on Economics 67554, London School of Economics and Political Science, LSE Library.
    21. Martijn Cremers & Rocco Huang & Zacharias Sautner, 2008. "Internal Capital Markets and Corporate Politics in a Banking Group," Yale School of Management Working Papers amz2464, Yale School of Management, revised 01 Oct 2009.

    More about this item

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • H12 - Public Economics - - Structure and Scope of Government - - - Crisis Management

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:hrv:hksfac:9946786. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Office for Scholarly Communication (email available below). General contact details of provider: https://edirc.repec.org/data/ksharus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.