Economic Consequences of Alternative Fixed-Cost Allocations in a Principal-AGENT SETTING

The paper analyses the differential effect of alternative fixed-cost allocations on managerial effort and risk sharing. In doing so, two alternative schemes are considered: (1) the lump-sum allocation; and (2) the proportional allocation. Analyses are conducted in the context of a principal-agent relationship where the principal retains the prerogative of fixed input decisions but delegates all other productive actions to the agent. The paper limits its focus to a simple class of linear sharing rules that guarantee the agent a fractional share of payoff and a fixed salary. The following summarises the major results of the paper. First, the lump-sum allocation is neutral in that it has no impact on the agents' choice of effort and the allocation of risk between the principal and the agent. Second, the proportional allocation is distortionary in that it induces the agent to exert less effort given a sharing rule and causes a shift in risk from the principal to the agent.