Which of the following explains why a compensation contract designed to combat employee moral hazard that features strong incentives might be worse than having no incentive scheme at all?
A) If performance depends on factors other than just the employee's effort, the strong incentives create large costs associated with risk bearing.
B) Employers are generally pretty skilled at measuring the aspects of job performance in which they are the most interested.
C) Generally, an employee's effort and ability are the only two determinants of the employee's performance.
D) This is a trick question; in the presence of moral hazard, even a poorly-designed incentive scheme is better than no incentive scheme.

Question

Quizplus · Accepted Answer

Strong incentives may lead employees to take on excessive risk, and the costs associated with this risk can be larger than the benefits of the incentivized behavior. This is especially true if factors outside of the employee's control (such as market conditions) heavily influence their performance, and the incentives do not account for this. In this case, it may be better for the employer to not have an incentive scheme at all.

Which of the Following Explains Why a Compensation Contract Designed