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

The authors empirically test Prendergast’s (2002) theory that incorporates the delegation of worker authority into the principal-agent model to explain the lack of consistent empirical support for a tradeoff between risk and incentives. Using data from the 1998 British WERS, the authors investigate whether there is: 1) evidence of a risk-incentives tradeoff as predicted by the principal-agent model; 2) evidence of a positive relationship between incentive pay and the delegation of worker authority; 3) evidence of a positive relationship between risk and authority; 4) 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 empirical model. The answers are affirmative for all four questions, thereby providing evidence clarifying the relationship between risk and incentive pay and how managers optimally bundle incentive pay and the delegation of worker decision rights to cope with risk. JEL Categories: