Foresighted outcome effect: A micro-foundation of agents’ risk aversion in principal-agent relations

Michal Livnat-Lerer, Raanan Sulitzeanu-Kenan, Tehila Kogut

Research output: Contribution to journalArticlepeer-review

Abstract

Agents’ risk aversion is a long-standing source of concern in principal-agent theory and in the practice of organizations. While standard principal-agent theory assumes that principals adequately infer conclusions from noisy outcomes, behavioral research suggests that their inferences are affected by outcome bias.
We take a further theoretical step, and propose that when an agent knows that the principal's evaluation of
the agent’s decision will be based on outcome knowledge, the agent expects the principal to be overly affected
by the outcome, rather than by the merit of the choice. As a result, the agent seeks to minimize the likelihood of an adverse outcome, leading to risk aversion. The results of three laboratory experiments support this hypothesis, suggesting that under outcome-knowledge-based principal-agent relationships, agents anticipate the effect of outcome bias on principals, and adjust their ex-ante behavior by opting for less risky alternatives, a phenomenon we call foresighted outcome effect.
Original languageEnglish
Pages (from-to)1-10
JournalJournal of Behavioral Public Administration
Volume1
Issue number1
StatePublished - 2018

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