Publisher's Synopsis
Excerpt from Agency Theory and Control Strategy: A Field Study
In conditions of uncertainty the agent must inevitably bear some risk. This is so because partial signals of effort may be used to deduce and compensate the effort supplied: alternatively. Output. Which is determined by factors other than simply the agent's level of effort, may be measured and used as the basis of an incentive contract. Since the agent is risk averse, the expected mean level of compensation must exceed the pure market rate for effort by a risk premium. At equilibrium the premium will exactly equal the agent's disutility for the riskiness of the situation. This equilibrium is called the second-best solution; that is to say. The solution which efficiently compensates the agent for both effort and risk. In this circumstance, the residual accruing to the principal comprises the output of the firm. Less the effort and risk compensation to the agent and monitoring costs.
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