On the Role of Uncertainty in the Risk-Incentives Tradeo¤

We use a simple agency model to clarify and characterize the various avenues through which changes in the level of uncertainty impact the optimal strength of linear incentives. Instead of attempting to characterize di¤erent "types" of uncertainty, which has been the approach in the literature so far, we base our characterization on the link between uncertainty and the agent’s action choice. We then use this characterization to provide conditions under which the relationship between uncertainty and incentives can be positive and relate it back to the existing models in the literature. Contact: [email protected]. I would like to thank my advisors Bengt Holmström and Robert Gibbons for their continuous encouragement and many helpful discussions, and the editor and two anonymous referees for their extremely helpful comments. All remaining errors are my own.