Rewarding successes discourages experimentation

Kimiko Terai, Amihai Glazer

Research output: Contribution to journalArticle

Abstract

Consider a principal who allocates a fixed budget among risk-averse agents. Each agent first chooses a policy or project. After observing the outcomes of their choices, the principal allocates a larger budget to the agents who had adopted the policy with the superior outcome. A subgame perfect Nash equilibrium may have all agents make the same choice, though the principal would prefer that they experiment. If the number of agents is large, or if the principal commits to reducing the aggregate budget when no agent had the superior outcome, or if he commits to avoid funding a riskless policy, different agents can be induced to adopt different policies.

Original languageEnglish
Pages (from-to)361-381
Number of pages21
JournalFinanzArchiv
Volume73
Issue number4
DOIs
Publication statusPublished - 2017 Dec 1

Keywords

  • Budget allocation
  • Experimentation
  • Federalism
  • Innovation
  • Risk aversion

ASJC Scopus subject areas

  • Finance

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