Incentives in optimally sized teams for projects with uncertain returns

Abstract

This paper analyzes a principal-agent model with three risk-averse players to investigate incentive provision and optimal team size in a setting with uncertain productivity and team synergies. A principal hires a team of workers and a manager to supervise the team. Workers provide productive effort, whereas the manager exerts effort to reduce measurement noise and productivity risk. We find that moral hazard is a limiting factor for team size and that the risk from uncertain productivity leads to smaller optimal teams, which stands in contrast to previous literature. Furthermore, we show that the manager’s and workers’ compensation increases with team size and that the pay differential between them is higher for larger teams. Our analysis demonstrates that the interdependency between team size and incentive provision makes it essential to coordinate the choice of these design variables.

Participating Institutions

TRR 266‘s main locations are Paderborn University (Coordinating University), HU Berlin, and University of Mannheim. All three locations have been centers for accounting and tax research for many years. They are joined by researchers from LMU Munich, Frankfurt School of Finance and Management, WHU – Otto Beisheim School of Management, ESMT Berlin, Goethe University Frankfurt and Carl von Ossietzky University Oldenburg who share the same research agenda.