Multi-task incentive contract and performance measurement with multidimensional types

This paper provides a new explanation for the dominance of the low-powered incentive contract over the high-powered incentive contract using a hybrid model of moral hazard and adverse selection. We first show that unobservable risk aversion or cost leads to low-powered incentives. We then consider the case where both risk aversion and cost of the agent are unobservable to the principal. This multidimensional mechanism design problem is solved under two assumptions with regard to the structures of performance measurement system and wage contract. It is shown that if the deterministic and stochastic components of performance measures vary proportionally, the principal is inclined to provide a low-powered incentive contract. Moreover, it is shown that if the base wage depends on a quadratic function rather than the direction of the performance wage vector, no incentive is provided for most of the performance measures in an orthogonal performance measurement system.