No full-text available
To read the full-text of this research,
you can request a copy directly from the authors.
Performance-Based Incentives in a Dynamic Principal-Agent Model
Abstract
The principal-agent paradigm, in which a principal has a primary stake in the performance of some system but delegates operational control of that system to an agent, has many natural applications in operations management (OM). However, existing principal-agent models are of limited use to OM researchers because they cannot represent the rich dynamic structure required of OM models. This paper formulates a novel dynamic model that overcomes these limitations by combining the principal-agent framework with the physical structure of a Markov decision process. In this model one has a system moving from state to state as time passes, with transition probabilities depending on actions chosen by an agent, and a principal who pays the agent based on state transitions observed. The principal seeks an optimal payment scheme, striving to induce the actions that will maximize her expected discounted profits over a finite planning horizon. Although dynamic principal-agent models similar to the one proposed here are considered intractable, a set of assumptions are introduced that enable a systematic analysis. These assumptions involve the "economic structure" of the model but not its "physical structure." Under these assumptions, the paper establishes that one can use a dynamic-programming recursion to derive an optimal payment scheme. This scheme is memoryless and satisfies a generalization of Bellman's principle of optimality. Important managerial insights are highlighted in the context of a two-state example called "the maintenance problem".
... This is despite the fact that dynamic Principal-Agent models can be significantly effective in providing insights into many areas of research, including those in the OM field. One of the first applications of dynamic Principal-Agent models in OM is [39], which studies a multiperiod setting without adverse selection (i.e., moral hazard only), where the transition probability matrices depend on the actions adopted by the agent. In [39], the principal seeks to make use of a payment mechanism that optimizes her expected discounted profit. ...
... One of the first applications of dynamic Principal-Agent models in OM is [39], which studies a multiperiod setting without adverse selection (i.e., moral hazard only), where the transition probability matrices depend on the actions adopted by the agent. In [39], the principal seeks to make use of a payment mechanism that optimizes her expected discounted profit. Ref. [39] presents a set of assumptions under which two typical difficulties of dynamic Principal-Agent models can be easily handled: (1) history dependence of compensation mechanisms which requires a (non-Markovian) complete information collection over time (i.e., information from all the previous periods) and (2) strategic commitment of both the principal and the agent (i.e., the agreement of both parties at time zero to restrict themselves to the terms for later payments). ...
... In [39], the principal seeks to make use of a payment mechanism that optimizes her expected discounted profit. Ref. [39] presents a set of assumptions under which two typical difficulties of dynamic Principal-Agent models can be easily handled: (1) history dependence of compensation mechanisms which requires a (non-Markovian) complete information collection over time (i.e., information from all the previous periods) and (2) strategic commitment of both the principal and the agent (i.e., the agreement of both parties at time zero to restrict themselves to the terms for later payments). When (a) the manager's (agent's) utility is an exponential type and additively separable over time, (b) the manager can move consumptions between periods (e.g., through saving and withdrawing income), and (c) the principle is a risk-neutral profit maximizer, [39] shows that the complex problem can be handled using a two-step dynamic programming setting. ...
When facing high levels of overstock inventories, firms often push their salesforce to work harder than usual to attract more demand, and one way to achieve that is to offer attractive incentives. However, most research on the optimal design of salesforce incentives ignores this dependency and assumes that operational decisions of production/inventory management are separable from design of salesforce incentives. We investigate this dependency in the problem of joint salesforce incentive design and inventory/production control. We develop a dynamic Principal‐Agent model with both Moral Hazard and Adverse Selection in which the principal is strategic and risk‐neutral but the agent is myopic and risk‐averse. We find the optimal joint incentive design and inventory control strategy, and demonstrate the impact of operational decisions on the design of a compensation package. The optimal strategy is characterized by a menu of inventory‐dependent salesforce compensation contracts. We show that the optimal compensation package depends highly on the operational decisions; when inventory levels are high, (a) the firm offers a more attractive contract and (b) the contract is effective in inducing the salesforce to work harder than usual. In contrast, when inventory levels are low, the firm can offer a less attractive compensation package, but still expect the salesforce to work hard enough. In addition, we show that although the inventory/production management and the design of salesforce compensation package are highly correlated, information acquisition through contract design allows the firm to implement traditional inventory control policies: a market‐based state‐dependent policy (with a constant base‐stock level when the inventory is low) that makes use of the extracted market condition from the agent is optimal. This work appears to be the first article on operations that addresses the important interplay between inventory/production control and salesforce compensation decisions in a dynamic setting. Our findings shed light on the effective integration of these two significant aspects for the successful operation of a firm. © 2014 Wiley Periodicals, Inc. Naval Research Logistics 61: 320–340, 2014
... Without it, the principal can essentially sell the entire enterprise to the agent, and therefore align incentives in a rather trivial fashion. The long-term optimal contract in [PZ00] is history-independent and renegotiation-proof. These nice properties rely critically on the borrowing and lending interest rates being exactly the same, and the agent's utility is additively separable and exponential. ...
... The approach of "promised utility" is not the only framework to address the dynamic contract problem. In operations management field, [PZ00], [ZZ08], and [ZTH19] develop a dynamic principal-agent framework to delegate operational control of a system that can be modeled as a Markov decision process. They assume that the agent is risk-averse and can access efficient banking with the same rate of borrowing and lending. ...
Business operations often need long-term contracts to manage incentives over time. In this proposal, we discuss three projects in designing long-term contracts in different incentive management settings. In the first chapter, we study an optimal contract design problem, where a principal hires an agent to repair a machine when it is down and maintain it when it is up. If the agent exerts effort, the downtime is shortened, and uptime is prolonged. Effort, however, is costly to the agent and unobservable to the principal. The principal, therefore, devises a mechanism to always induce the agent to exert effort while maximizing the principal's profits. In the second chapter, we consider a service management setting, where the principal hires an agent to provide services to customers. Customers request service in one of two ways: either via an online or a traditional, walk-in, channel. The principal does not observe the walk-ins, nor does she observe whether the agent exerts (costly) effort that can increase the arrival rate of customers. This leads to a novel so far unexplored double moral hazard problem. We also present dynamic contracts that maximize the principal's profit. In the third chapter, we study the optimal incentive scheme for a long-term Poisson project with both moral hazard and adverse selection. The project has a flow cost that must be reimbursed by the principal, but the agent privately observes the cost that he incurs. The principal's optimal contract is a menu that contains several items, each of which is prepared for a specific group of agents. The agents reveal their costs immediately after they pick their preferred contract. We fully characterize the optimal contracts in the case of two types of agents. When the number of agent types is infinite and the cost distribution is continuous, we formulate an easy-to-compute upper bound optimization problem to the original problem. This optimization problem further provides a way for us to design a menu of contracts. Our numerical study illustrates that the proposed menu of contracts is indeed optimal with commonly used distributions.
... Fudenberg et al. [9] pioneered a dynamic principal-player model centered on a stochastic process with hidden actions, advocating for the breakdown of optimal long-term contracts into easily computable short-term contracts. Plambeck and Zenios [10] extended this study by integrating the principal-player model with the physical structure of a Markov decision process, providing a dynamic model that captures the intricate interplay between hidden actions and stochastic processes. Cole and Kocherlakota [11] further advanced this field by proposing a solution for dynamic Markov games where each player's actions remain unobservable to others, and these actions can influence an unobservable state variable. ...
This paper introduces a dynamic mechanism design tailored for uncertain environments where incentive schemes are challenged by the inability to observe players’ actions, known as moral hazard. In these scenarios, the system operates as a Markov game where outcomes depend on both the state of payouts and players’ actions. Moral hazard and adverse selection further complicate decision-making. The proposed mechanism aims to incentivize players to truthfully reveal their states while maximizing their expected payoffs. This is achieved through players’ best-reply strategies, ensuring truthful state revelation despite moral hazard. The revelation principle, a core concept in mechanism design, is applied to models with both moral hazard and adverse selection, facilitating optimal reward structure identification. The research holds significant practical implications, addressing the challenge of designing reward structures for multiplayer Markov games with hidden actions. By utilizing dynamic mechanism design, researchers and practitioners can optimize incentive schemes in complex, uncertain environments affected by moral hazard. To demonstrate the approach, the paper includes a numerical example of solving an oligopoly problem. Oligopolies, with a few dominant market players, exhibit complex dynamics where individual actions impact market outcomes significantly. Using the dynamic mechanism design framework, the paper shows how to construct optimal reward structures that align players’ incentives with desirable market outcomes, mitigating moral hazard and adverse selection effects. This framework is crucial for optimizing incentive schemes in multiplayer Markov games, providing a robust approach to handling the intricacies of moral hazard and adverse selection. By leveraging this design, the research contributes to the literature by offering a method to construct effective reward structures even in complex and uncertain environments. The numerical example of oligopolies illustrates the practical application and effectiveness of this dynamic mechanism design.
... There is a rich and extensive literature on principal-agent models in economics (Holmström 1979, Grossman and Hart 1983, Hart and Holmström 1987 and in operations management (Martimort and Laffont 2009). For repeated models, most existing studies focuses on the moral hazard setting (Radner 1981, Rogerson 1985, Spear and Srivastava 1987, Abreu et al. 1990, Plambeck and Zenios 2000, Conitzer and Garera 2006, Sannikov 2008, 2013. Several of them study the problem of estimating the agent's model when actions are hidden (Vera-Hernandez 2003, Misra et al. 2005, Misra and Nair 2011, Ho et al. 2016, Kaynar and Siddiq 2022. ...
Motivated by a number of real-world applications from domains like healthcare and sustainable transportation, in this paper we study a scenario of repeated principal-agent games within a multi-armed bandit (MAB) framework, where: the principal gives a different incentive for each bandit arm, the agent picks a bandit arm to maximize its own expected reward plus incentive, and the principal observes which arm is chosen and receives a reward (different than that of the agent) for the chosen arm. Designing policies for the principal is challenging because the principal cannot directly observe the reward that the agent receives for their chosen actions, and so the principal cannot directly learn the expected reward using existing estimation techniques. As a result, the problem of designing policies for this scenario, as well as similar ones, remains mostly unexplored. In this paper, we construct a policy that achieves a low regret (i.e., square-root regret up to a log factor) in this scenario for the case where the agent has perfect-knowledge about its own expected rewards for each bandit arm. We design our policy by first constructing an estimator for the agent's expected reward for each bandit arm. Since our estimator uses as data the sequence of incentives offered and subsequently chosen arms, the principal's estimation can be regarded as an analogy of online inverse optimization in MAB's. Next we construct a policy that we prove achieves a low regret by deriving finite-sample concentration bounds for our estimator. We conclude with numerical simulations demonstrating the applicability of our policy to real-life setting from collaborative transportation planning.
... In turn, the farmers' actions and states do influence the Organization rewards. This specific problem is often called Leader-Follower Markov Decision Process (LF-MDP) (Tharakunnel and Bhattacharyya 2009) or Dynamic Principal-Agent Problem (Plambeck and Zenios 2000). ...
Sustainable animal disease management requires to design and implement control policies at the regional scale. However, for diseases which are not regulated, individual farmers are responsible for the adoption and successful application of control policies at the farm scale. Organizations (groups of farmers, health institutions...) may try to influence farmers' control actions through financial incentives, in order to ensure sustainable (from the health and economical point of views) disease management policies. Economics / Operations Research frameworks have been proposed for modeling the effect of incentives on agents. The Leader-Follower Markov Decision Processes framework is one such framework, that combines Markov Decision Processes (MDP) and stochastic games frameworks. However, since finding equilibrium policies in stochastic games is hard when the number of players is large, LF-MDP problems are intractable. Our contribution, in this article, is to propose a tractable model of the animal disease management problem. The tractable model is obtained through a few simple modeling approximations which are acceptable when the problem is viewed from the organization side. As a result, we design a polynomial-time algorithm for animal disease management, which we evaluate on a case study inspired from the problem of controlling the spread of the Porcine Reproductive and Respiratory Syndrome (PRRS).
... Our work is related to incentives in insurance programs, for which there is much literature [6,12,13], whose root is in the principal-agent problem [14]. Previous work has also focused on analyzing risk adjustment under Medicare Advantage and other programs [5,6,[15][16][17][18] and the ACA exchanges [19][20][21][22][23][24][25]. ...
Under the Affordable Care Act (ACA), insurers cannot engage in medical underwriting and thus face perverse incentives to engage in risk selection and discourage low-value patients from enrolling in their plans. One ACA program intended to reduce the effects of risk selection is risk adjustment. Under a risk adjustment program, insurers with less healthy enrollees receive risk transfer payments from insurers with healthier enrollees. Our goal is to understand the elements driving risk transfers. First, the distribution of risk transfers should be based on random health shocks, which are unpredictable events that negatively affect health status. Second, risk transfers could be influenced by factors unique to each insurer, such as certain plans attracting certain patients, the extent to which carriers engage in risk selection, and the degree of upcoding. We create a publicly available dataset using Centers for Medicare and Medicaid Services data that includes insurer risk transfer payments, costs, and premiums for the 2014-2017 benefit years. Using this dataset, we find that the empirical distribution of risk transfer payments is not consistent with the lack of risk selection as measured by the ACA risk transfer formula. Over all states included in our dataset, at least 60% of the volume of transfers cannot be accounted for by a purely normal model. Because we find that it is very unlikely that risk transfer payments are caused solely by random shocks that reflect health events of the population, our work raises important questions about the causes of heterogeneity in risk transfers.
... In the organizational behavior literature, employee incentives are often regarded as a motivator that enables employees to apply their knowledge and skills to certain tasks in order to achieve organizational goals. There are diverse incentive strategies including performance-based (Plambeck and Zenios, 2000), process-based (Banker et al., 1996;Quentier, 2012) and goal-based (Locke and Latham, 1990;Tubbs and Ekeberg, 1991). This study restricts our current view to goal-based incentive systems for two reasons. ...
Purpose
Cross-functional integration has been an important factor for manufacturing firms' performance outcomes. The study aims to expand previous research by investigating the moderating role of goal-based incentive systems in the relationship between cross-functional integration and competitive performance.
Design/methodology/approach
Based on multi-source data from 269 manufacturing firms around the world, regression analysis is used to test the proposed research model.
Findings
The authors' findings suggest that cross-functional integration enhances manufacturers' innovation and operational performance. Moreover, cross-functional integration has a stronger impact on operational performance when firms implement a well-designed goal-based incentive system. However, the authors find that the goal-based incentive system does not moderate the relationship between cross-functional integration and innovation performance.
Originality/value
The study, by investigating the fit between goal-based incentive systems and cross-functional integration, provides practical insights into the ways that firms apply cross-functional integration and goal-based incentive systems to enhance competitive performance.
... al. (2015). 4 Nwogugu (2006a), Dai, Li & Sun (2012), Wang & Zipkin (2009) and Plambeck & Zenios (2000). 5 Banerjee, Güçbilmez & Pawlina (2014) and Engelen (2004). ...
... On Equity-Based Incentives and Supply Chain finance, Networks and Buy-Back Contracts, see Dai, Li & Sun (2012), Wang & Zipkin (2009), and Plambeck & Zenios (2000). On the optimal exercise of employee stock options within the context of Operations Research, see: Carmona, León & Vaello-Sebastià (2012), Wu & Fu (2003), Li & Linetsky (2012), Kaniel, Tompaidis & Zemlianov (2008), Heron & Lie (2016), Brenner (2014), and McCann & Thomas (2004). ...
This article analyzes Equity Based Incentives ("EBIs") within the context of Pandemics, Economic/Financial Crises and "Disorganized Networks" (networks of employees, regulators, companies, shareholders and investors whom are directly or indirectly connected by computer/communication systems). EBIs remain the dominant form of incentives in many developed and developing countries; and thus have significant effects on the quality-of-life of individuals in both small and large firms. The timing of exercise of EBIs and the associated legal and economic ramifications have generated substantial debate, which is complicated by Pandemics and Economic/Financial Crisis. This article: i) critiques existing academic thought on information (disseminated primarily through the Internet) and exercise of employees' incentive contracts within the context of "Learning", evolution and industry competition, ii) shows how Equity-Based Incentives ("EBIs") cause information asymmetry, and vice versa in Information Networks (even with substantial Internet access/penetration), iii) under combined "Learning", evolution, WTAL and Regret Minimization Regimes, introduces the optimal conditions for exercise of EBIs by 'insiders' in an era of Internet-mediated information diffusion; and new methods/conditions to control the monetization of EBIs by executives/employees; and new distribution-free methods/models for the prediction and prevention of the monetization of EBIs; iv) these models incorporate "Learning" and evolution, and can incorporate estimates of future states of the subject company, behavior patterns (of investors and employees) and the Stock markets and some of the conditions introduced herein are or can be transformed into alternative risk premia strategies; v) explains how the option exercise decision is part of, and affects capital budgeting decisions of firms; vi) applies MN-Transferable-Utility, and introduces the "Flexible Utility Framework" which implicitly assigns a dynamic utility function to specific instances.
... Fudenberg et al. (1990) introduce stochastic elements to a dynamic principal-agent model and identify conditions under which a long-term contract can be implemented as a sequence of short-term contracts. Plambeck and Zenios (2000) provide an analysis of a previously intractable setting relying on assumptions about the "economic structure" of principal-agent interaction, and Fuloria and Zenios (2001) build upon this dynamic model in the context of healthcare contracting. Shumsky and Pinker (2003) study the compensation system a firm should offer a gatekeeper who has private knowledge about the complexity of a customer's problem and their ability to treat it. ...
This dissertation studies the role of performance-based incentives in public sector service operations. In particular, we consider incentives in the context of K-12 education and healthcare. These systems share three key characteristics: the quality of service provision depends both on the efforts of the service provider and customer, the provider is paid by a third-party, and measuring the quality of service provision is difficult. In three chapters, we study different facets of the incentive problem. In the first chapter, we consider the problem faced by school districts seeking to maximize student performance, as measured by annual state exams. Using a dynamic two-period principal-agent model, we study the interaction between two levers that the school district can use to improve performance: a midyear “interim assessment,” which will more accurately gauge whether students are on track to perform well, and performance-based incentives for teachers. We show that investing in an interim assessment is beneficial in only a limited number of scenarios; our results suggest that the growing dependence on third-party assessments may be misplaced. In the second chapter, we turn to healthcare. We study the problem faced by a profit- maximizing, resource-constrained hospital that controls patient inflows by designing a case- mix of its elective procedures and patient outflows via patient discharges. We consider a hospital that makes these decisions in the presence of bundled payments, which implicitly penalize high readmission rates. In our analysis, we focus on assessing the benefits associated with the hospital employing a coordinated decision-making process, in which both portfolio and discharge decisions are made in tandem. We compare a coordinated decision-making structure to two commonly utilized decision-making structures and characterize when the hospital can most benefit from coordination. Finally, in the third chapter, we return to K-12 education. We study the impact of coproduction on the student performance in the presence of merit-based rewards for both teachers and students, using a Cobb-Douglas formulation of the education production function and a Stackelberg model of teachers’ and students’ effort decisions. We characterize students’ and teachers’ optimal effort levels for a given reward allocation, and we illustrate the impact on student performance.
... However, the leader does not influence the dynamics of the stochastic game, which is only governed by the followers' actions. Some recent applications of the LF-MDP framework include management in organizations [21,13]. ...
The Leader-Follower Markov Decision Processes (LF-MDP) framework extends both Markov Decision Processes (MDP) and Stochastic Games. It provides a model where an agent (the leader) can influence a set of other agents (the followers) which are playing a stochastic game, by modifying their immediate reward functions, but not their dynamics. It is assumed that all agents act selfishly and try to optimize their own long-term expected reward. Finding equilibrium strategies in a LF-MDP is hard, especially when the joint state space of followers is factored. In this case, it takes exponential time in the number of followers. Our theoretical contribution is threefold. First, we analyze a natural assumption (substitutability of followers), which holds in many applications. Under this assumption, we show that a LF-MDP can be solved exactly in polynomial time, when deterministic equilibria exist for all games encountered in the LF-MDP. Second, we show that an additional assumption of sparsity of the problem dynamics allows us to decrease the exponent of the polynomial. Finally, we present a state-aggregation approximation, which decreases further the exponent and allows us to approximately solve large problems. We empirically validate the LF-MDP approach on a class of realistic animal disease control problems. For problems of this class, we find deterministic equilibria for all games. Using our first two results, we are able to solve the exact LF-MDP problem with 15 followers (compared to 6 or 7 in the original model). Using state-aggregation, problems with up to 50 followers can be solved approximately. The approximation quality is evaluated by comparison with the exact approach on problems with 12 and 15 followers.
... One reason so few authors focusing on management theories have studied the problem of maintenance outsourcing in general, and the performance of third party medical device maintenance providers in particular, is that the subject is so narrow that contribution from the management theory field has been insignificant. Yet, despite receiving little attention from scholars, the multiperiod machine maintenance problem with delegated control is a very general problem requiring empirical investigation (Plambeck and Zenios, 2000). ...
This study aims to examine the effects of maintenance service firms’ resources and capabilities on maintenance performance, measured by the turnaround time of medical devices (TAT). The theoretical framework used in this study is based on the resource-based view (RBV) and agency theory (AT). The hypotheses were tested using information on 764 medical devices and 60 maintenance service providers, resulting in 1403 maintenance transactions. As such, our data sample is significantly larger than those used in previous studies in this area. For this study we used a variation of the proportional hazards model, the conditional frailty gap time hazards model. The empirical analysis of this research is among the first to quantify how the performance of maintenance providers is affected by the core constructs of both the resource-based view and agency theory, using statistical evidence.
... Since public healthcare services are typically constrained by the government's budget, some recent studies such as Hua et al. (2016), Chen et al. (2015), and Qian et al. (2017) consider how to achieve the maximum benefit and greater efficiency of the 10 / 56 healthcare system via government subsidy schemes. In addition, Jiang et al. (2012) and Plambeck and Zenios (2000) explore a performance-based approach to contracts for healthcare services under a principal-agent framework. However, our work differs from the above research by mainly focusing on the healthcare referral efficiency of a two-tier healthcare system, and how to stimulate a CHP to transfer its patients to a PHP. ...
Healthcare referral has been widely advocated and adopted through the implementation of the two-tier healthcare systems whereby patients are transferred from a comprehensive hospital provider (CHP) to a primary hospital provider (PHP). However, operationally, exactly how to implement the healthcare referral program remains a challenging research question, especially when considering the possibility of patient revisits and the coordination needed between the CHP and PHP. To address such a challenge, this paper considers the two-tier healthcare systems consisting of a CHP and a PHP. By establishing a three-stage Stackelberg game within a queuing framework among the CHP, the PHP, and their patients, we first investigate the equilibrium strategy in terms of the CHP’s referral rate and the PHP’s capacity level, and then examine the impact of revisit rates and referral payments (RP) on the healthcare system and the equilibrium outcomes (e.g., expected utility, social welfare, and waiting times). Two major findings of our study are: (1) both the equilibrium referral rate and the equilibrium capacity first increase and then decrease according to the revisit rate; in addition, the patient referral process always improves the PHP's performance but is likely to sacrifice the social welfare of the CHP. (2) There exists an RP threshold value such that if the RP is below the threshold, then all the permitted patients should be referred and the system performance will be enhanced, in which case a win-win situation in terms of expected utilities can be attained that benefits all the stakeholders, i.e., the CHP, the PHP, and the patients. Otherwise, only a portion of the permitted patients can be referred, and an increase in RP always reduces the efficiency of the healthcare delivery system, i.e., a higher RP mitigates the operational performance of the healthcare system. Our analysis sheds light on how to implement a healthcare referral scheme.
... However, the service provider is susceptible to incentive issues because its effort in performing repairs directly affects the maintenance outcomes and yet cannot be observed by the customer. Plambeck and Zenios (2000) studies such a setting with a dynamic single principal and single agent model. Kim et al. (2007) uses a one-shot single principal with multiple agents to study a maintenance setting in which the service providers can affect maintenance outcomes by altering the inventory level of spare parts. ...
Maintenance service plans (MSPs) are contracts for the provision of maintenance by a service provider to an equipment operator. These plans can have different payment structures and risk allocations, which induce various types of incentives for agents in the service chain. How do such structures affect service performance and service chain value? We provide an empirical answer to this question by using unique panel data covering the sales and service records of more than 700 diagnostic body scanners. We exploit the presence of a standard warranty period and employ a matching approach to isolate the incentive effects of MSPs from the confounding effects of endogenous contract selection. We find that moving the equipment operator from a basic, pay-per-service plan to a fixed-fee, full-protection plan not only reduces reliability but also increases equipment service costs. Furthermore, that increase is driven by both the operator and the service provider. Our results indicate that incentive effects arising from MSPs leads to losses in service chain value, and we provide the first evidence that a basic pay-per-service plan—under which risk of equipment failure is borne by the operator—can improve performance and reduce costs.
This paper was accepted by Gad Allon, operations management.
... They show that the insurance coverage structure is the key driver of the physicians' overtesting behavior. Other research papers in this stream include Plambeck and Zenios (2000), Yaesoubi and Roberts (2011) and Ata et al. (2013). However, none of these works considers the BP scheme. ...
This paper examines the impact of two reimbursement schemes, fee-for-service and bundled payment, on the social welfare, the patient revisit rate, and the patient waiting time in a public healthcare system. The two schemes differ on the payment mechanism: under the fee-for-service scheme, the healthcare provider receives the payment each time a patient visits (or revisits) whereas, under the bundled payment scheme, the healthcare provider receives a lump sum payment for the entire episode of care regardless of how many revisits a patient incurs. By considering the quality-speed trade-off (i.e., a higher service speed reduces service quality, resulting in a higher revisit rate), we examine a three-stage Stackelberg game to determine the patients’ initial visit rate, the service provider’s service rate (which affects the revisit rate), and the funder’s reimbursement rate. This analysis enables us to compare the equilibrium outcomes (social welfare, revisit rate, and waiting time) associated with the two payment schemes. We find that when the patient pool size is large, the bundled payment scheme dominates the fee-for-service scheme in terms of higher social welfare and a lower revisit rate, whereas the fee-for-service scheme prevails in terms of shorter waiting time. When the patient pool is small, the bundle payment scheme dominates the fee-for-service scheme in all three performance measures.
The online appendix is available at https://doi.org/10.1287/msom.2017.0690 .
... They show that the insurance coverage structure is the key driver of the physicians' overtesting behavior. Other research papers in this stream include Plambeck and Zenios (2000), Yaesoubi and Roberts (2011) and Ata et al. (2013). However, none of these works considers the BP scheme. ...
... Agency problems have long been the essential issues in operating systems, since most operating systems are generally delegated by the principal and executed by the agents (Plambeck and Zenios 2000). Over the past decade, agency models in economics or operations management have focused on incorporating social preferences (e.g., inequity-averse/fairness, sympathy, competitiveness, and status-seeking), and studying how they influence incentive schemes and agents' behaviors in operating systems. ...
We model how inequity-averse agents’ deserved concerns generated by a social network setting impact on their behaviors and interactions under linear contract. Based on self-perception in the network, the agent will have deserved perception on the two essential elements of linear contract, i.e., deserved fixed wage and deserved output sharing, and thus generate deserved pay gap. By incorporating deserved pay gap into pay comparisons, we obtain three main findings: (1) perceived relative incentive fairness or inequity over the entire networks decides agents’ effort competition. When agents perceive over-incentivized over the networks, the heterogeneity in the network will stimulate agents to compete. While in an overall under-incentivized network, the agent tends to compete with homogenous ones, and will instead reduce effort with increasing heterogeneity in the network; (2) the normal conclusion that inequity aversion can enhance agent effort will be reversed when the agent perceives under-incentivized; and (3) wage compression remains valid, yet we provide a definitive range for the optimal incentive level.
... However, the service provider is susceptible to incentive issues because its effort in performing repairs directly affects maintenance outcomes yet cannot be observed by the customer. Plambeck and Zenios (2000) studies such a setting with a dynamic single principal and single agent model. Kim et al. (2007) uses a one-shot single principal with multiple agents to study a maintenance setting in which the service providers can affect maintenance outcomes by altering the inventory level of spare parts. ...
Equipment manufacturers offer different types of maintenance service plans (MSPs) that delineate payment structures between equipment operators and maintenance service providers. These MSPs allocate risks differently and thus induce different kinds of incentives. A fundamental question, therefore, is how such structures impact service performance and the service chain value. We answer empirically this question. Our study is based on a unique panel data covering the sales and service records of over 700 diagnostic medical body scanners. By exploiting the presence of a standard warranty period, we overcome the key challenge of isolating the incentive effects of MSPs on service performance from the confounding effects of adverse selection. We found that moving an operator from a basic pay-per-service plan to a fixed-fee full-protection plan leads to both a reduction in reliability and an increase in service costs. We further show that the increase in cost is driven by both the operator and the service provider. Our results point to the presence of losses in service chain value in the maintenance of medical equipment, and provide the first evidence that a basic pay-per-service plan, where the risk of equipment failure is borne by the operator, can actually improve performance and costs.
... Employee incentives are designed to motivate employees to apply their knowledge and skills to specific tasks and achieve company goals. There are many kinds of incentive strategies, such as performance- (Plambeck and Zenios, 2000), process- (Banker et al., 1996;Quentier, 2012) and goal-based (Locke and Latham, 1990;Tubbs and Ekeberg, 1991) 719 Supply chain integration incentives. Following Ahmad and Schroeder (2003), we focus on goal-based employee incentives in this study. ...
Purpose
– Taking an interdisciplinary approach, the purpose of this paper is to combine concepts from human resource management (HRM) and supply chain management (SCM) fields and explore the effects of high-involvement HRM practices on supply chain integration (SCI).
Design/methodology/approach
– Using empirical survey data collected from ten countries, the authors examine the specific effects of three dimensions of high-involvement HRM practices – employee skills, incentives and participation – on three types of SCI – internal integration, supplier and customer integration. The authors use structural equation modeling and the maximum-likelihood estimation method to test the proposed relationships.
Findings
– The results confirm the overall relevancy of HRM to SCI. However, several proposed links are not supported by the data collected.
Originality/value
– This study makes both theoretical and managerial contributions by empirically examining the interface between HRM and SCI. More specifically, it examines the effects of different high-involvement HRM practices on different types of SCI. The findings will not only help researchers to better understand the interface, but will also guide managers in adjusting HRM practices to achieve desired operational goals.
U.S. K–12 school districts that traditionally utilized ongoing “formative” assessments of student progress increasingly rely on additional “interim” assessments to predict student performance on standardized tests. Moreover, some districts are experimenting with merit-based teacher bonuses tied to standardized test scores. We examine the relationship between interim assessments and teacher bonuses using a two-period principal–agent model. The school district (principal), operating under a limited budget, decides whether to implement interim assessments and how much merit pay to offer, and teachers (agents) choose how much effort to exert in each period. We use two-state (proficient versus not proficient) Markovian dynamics to describe the evolution of student test readiness, in which the transition probability in a given period depends on both teachers’ effort decisions and the starting state. Our results indicate that, despite the popularity of interim assessments, their usefulness is far from guaranteed. In particular, the accuracy promised by these assessments is a double-edged sword: positive midyear results can make it easier to incentivize second period teacher effort, but negative results can have a demotivating effect. Moreover, even when an interim assessment does result in a higher probability of the school ending the year in the proficient state, the resulting higher expected costs of merit-based bonuses for the district may exceed the available budget. Thus, even a free interim assessment might be too expensive for the school district.
This paper was accepted by Charles Corbett, operations management.
Funding: This research was supported by the Risk Management Center Russell Ackoff Doctoral Student Fellowship and the Fishman-Davidson Center for Service and Operations Management, both at The Wharton School, University of Pennsylvania, Philadelphia, Pennsylvania.
Supplemental Material: The online appendix is available at https://doi.org/10.1287/mnsc.2020.01547 .
Contract Design for Outsourcing Search
Firms commonly outsource search for new employees, real estate, or technology to external agents. What should the contracts with these agents look like, and under which conditions should companies even hire agents (as opposed to doing the search in house)? These are the questions studied in “The when and how of delegated search” by Zorc et al. The authors find that the optimal contracts pay the agent a per-time fee as well as a bonus for finding an acceptable alternative. The size of this bonus is defined on signing of the contract and decreases over time. The decision of whether to outsource at all hinges on the firm’s trade-off between speed and quality; in-house search becomes optimal for a firm that prioritizes quality, but outsourcing offers better speed.
This study considers a new product development supply chain consisting of a client and a delegated vendor, and applies a differential game to capture three forms of contracts (original contract, incentive contract, and co-creation contract) with the consideration of the uncertainty of production reliability and variable diagnostic test time. We show that if the client cooperates with an extremely high-reliability (relatively low-reliability) vendor, it is preferable to provide the original contract (incentive contract) and schedule the diagnostic tests early. If the client is working with an extremely low-reliability vendor, nevertheless, offering a contract and providing a later schedule for diagnostic test would be the best decision. Surprisingly, if the client’s partner has relatively high production reliability, offering co-creation contracts is still the best option. The reason is that within this range of reliability, the incentive effect of the incentive contract is diminished and the original contract is not sufficiently reliable. These findings suggest that firms must offer contracts as appropriate and rationalize diagnostic test schedules when cooperating with a new partner to ease delayed delivery caused by uncertain production reliability.
Problem definition: Condition monitoring (CM) of durable assets, whereby sensors continuously monitor the health of an asset, is heralded as a key application of the Internet of Things. However, questions about ownership of the sensor data are seen as a key barrier to adoption. We model an after-sales supply chain in which the asset manufacturer provides maintenance and repair services to a customer that operates the asset. The asset condition deteriorates in a stochastic fashion and will eventually fail if not repaired. Methodology/results: We analyze a performance-based contracting problem considering manufacturer maintenance effort (the condition at which preventive maintenance is performed) and customer operating effort (which reduces the rate of condition deterioration). With information asymmetry on the customer’s effort cost, we analyze this contracting problem in a principal-agent model with double moral hazard. In the centralized setting, we establish that the benefit of CM increases and then decreases in the asset’s deterioration rate and that CM may increase or decrease the benefit of customer effort depending on the deterioration rate. In the decentralized setting, we prove that CM always benefits the manufacturer and the supply chain, but it may hurt the customer if the asset reliability is sufficiently high. Managerial implications: These results have important implications for the effect of sensor-data ownership. The manufacturer will adopt CM if it owns the data, but the customer may block CM adoption if it owns the data. We show that this CM adoption barrier can be overcome by the manufacturer offering to pay an appropriate data access fee. However, under this arrangement, the manufacturer may not benefit from a more-effective customer operating effort. We discuss the resulting implication on the manufacturer’s product design and the business model between selling and leasing.
In this paper, we study the agency problem in an organisation within a Markovian framework. More specifically, the paper presents the case of a principal imposing an incentive-control structure upon an agent to force him to follow the principal’s interests for which he was hired, against the tendency of the agent to follow his own interests. Findings point toward the principal’s difficulty in controlling the behaviour of the agent through incentives and monitoring; instead, best results are obtained when hiring agents who care for their reputation and refrain from unprofessional behaviours. The implication is that if we consider that it might be difficult to identify this characteristic at the time of the agent’s hiring, the best criterion will be to look for low levels of greed in the agent. This conclusion goes in some way against current practices of looking for aggressive agents for the generation of higher profits. Nevertheless, it should be noted that these potential benefits might actually fade away if the agent follows his own interests, instead of the principal’s. Another interesting result points to the restricted, although necessary, role of monitoring to control the agent’s behaviour, a result that goes against current research interests on measures of corporate governance. The paper is a contribution to expert decision-making.
Maintenance outsourcing is quite common in industries that rely on complex and critical equipment. Instead of investing in the maintenance facilities, firms outsource maintenance activities to specialized companies. However, it may be hard for firms (i.e., principal) to observe whether maintenance companies (i.e., agent) put sufficient resources into providing the best service, which gives rise to agency issues. In a dynamic environment in which an agent is responsible for both maintenance and repair of a critical machine, how the principal uses payments and termination to tackle agency issues is a challenging problem. In “Optimal Contract for Machine Repair and Maintenance,” F. Tian, P. Sun, and I. Duenyas provide theoretical guidance on designing the optimal contract to induce efforts from an agent to efficiently operate a machine. Although they consider the very general contract forms, the optimal contracts demonstrate simple and intuitive structures, making them easy to describe and implement in practice.
We investigate incentive schemes for a sustainable waste and cost reduction activity in a dyadic supply chain. The buyer motivates the internal operations department and external supplier to reduce the supply chain's overall production cost by reducing the waste and energy consumption. By incorporating players' risk aversion and opportunity loss as in practice, we construct three benefit-sharing models: two cost target models to maintain unit profit and profit ratio (UP and PR) and one with no target (NT). Then, we reveal that the benefit-sharing scheme yielding superior cost performance varies depending on the market situation and the relationship intensity between players. In a highly strategic buyer-supplier relationship, the NT scheme yields the best result if the supply chain maintains a low profit ratio. The PR scheme is superior with the high original profit ratio. When the buyer maintains a transactional relationship with the supplier, adopting the UP scheme always guarantees superior cost reduction performance.
Healthcare referral has been widely advocated and adopted through the implementation of the two-tier healthcare systems whereby patients are transferred from a comprehensive hospital provider (CHP) to a primary hospital provider (PHP). However, operationally, exactly how to implement the healthcare referral program remains a challenging research question, especially when considering the possibility of patient revisits and the coordination needed between the CHP and PHP. To address such a challenge, this paper considers the two-tier healthcare systems consisting of a CHP and a PHP. By establishing a three-stage Stackelberg game within a queuing framework among the CHP, the PHP, and their patients, we first investigate the equilibrium strategy in terms of the CHP’s referral rate and the PHP’s capacity level, and then examine the impact of revisit rates and referral payments (RP) on the healthcare system and the equilibrium outcomes (e.g., expected utility, social welfare, and waiting times). Two major findings of our study are: (1) both the equilibrium referral rate and the equilibrium capacity first increase and then decrease according to the revisit rate; in addition, the patient referral process always improves the PHP's performance but is likely to sacrifice the social welfare of the CHP. (2) There exists an RP threshold value such that if the RP is below the threshold, then all the permitted patients should be referred and the system performance will be enhanced, in which case a win-win situation in terms of expected utilities can be attained that benefits all the stakeholders, i.e., the CHP, the PHP, and the patients. Otherwise, only a portion of the permitted patients can be referred, and an increase in RP always reduces the efficiency of the healthcare delivery system, i.e., a higher RP mitigates the operational performance of the healthcare system. Our analysis sheds light on how to implement a healthcare referral scheme.
Purpose: In performance-based contracting (PBC), the provider is paid according to outcomes for its customer, and therefore assumes responsibility for customer risks. Previous studies have revealed that risk exposure is a fundamental influencing factor. Thus, the purpose of this paper is to analyze how previous experience with PBC influences the perception of risks.
Design/methodology/approach: This research is based on a cross-industry study. Factor analysis and discriminant analysis are used to reveal to what extent experience influences PBC risk factors.
Findings: It is confirmed that risk perception differs significantly according to previous PBC experience. Thus, significant learning effects are identified in the PBC context.
Research limitations/implications: Experiential learning in PBC can explain entry barriers to PBC faced by new buyers with low levels of experience. Although the internal validity of the sample is high, as all analyzed cases represent PBC buying companies, there are limitations related to external validity.
Practical implications: To manage risks this study provides a structure (12 risks, 3 aggregated factors), which could be used for risk evaluation and strategic and operative risk management. Other implications recommend, e.g., to collaborate with a PBC “veteran” when entering into PBC, as this boosts the level of PBC-related experience.
Originality/value: The findings of this study contribute to identifying PBC risks through the explorative statistical assessment of these PBC risk factors.
The gig economy, where employees take short-term, project-based jobs, is increasingly spreading all over the world. In this paper, we investigate the employer's and the worker's behavior in the gig economy with a dynamic principal-agent model. In our proposed model the worker's previous decisions influence his later decisions through his dynamically changing participation constraint. He accepts the contract offered by the employer when his expected utility is higher than the irrational valuation of his effort's worth. This reference point is based on wages he achieved in previous rounds. We formulate the employer's stochastic control problem and derive the solution in the deterministic limit. We obtain the feasible net wage of the worker, and the profit of the employer. Workers who can afford to go unemployed and need not take a gig at all costs will realize high net wages. Conversely, far-sighted employers who can afford to stall production will obtain high profits.
We develop a simple sufficient condition for an optimal contract of a moral hazard problem to be monotone in the output signal. Existing results on monotonicity require conditions on the output distribution (namely, the monotone likelihood ratio property (MLRP)) and additional conditions to guarantee that agent’s decision is approachable via the first-order approach of replacing that problem with its first-order conditions. We know of no positive monotonicity results in the setting where the first-order approach does not apply. Indeed, it is well documented that when there are finitely many possible outputs, and the first-order approach does not apply, the MLRP alone is insufficient to guarantee monotonicity. However, we show that when there is an interval of possible output signals, the MLRP does suffice to establish monotonicity under additional technical assumptions that do not guarantee the validity of the first-order approach. To establish this result we examine necessary optimality conditions for moral hazard problems using a novel penalty function approach. We then manipulate these conditions and provide sufficient conditions for when they coincide with a simple version of the moral hazard problem with only two constraints. In this two-constraint problem, monotonicity is established directly via a strong characterization of its optimal solutions.
The e-companion is available at https://doi.org/10.1287/opre.2018.1720 .
This paper studies the impact of two decision makers’ interaction with conflicts on the efficiencies of the system. We start with a general principal-agent framework where the principal and the agent make decisions independently and the principal has a contradictive objective to that of the agent. We develop data envelopment analysis (DEA) models in the principal’s and the agent’s perspectives respectively. Non-cooperation between the principal and the agent is discussed to illustrate how one decision maker affects the other and the corresponding efficiency and incentive contract of the system. In addition, cooperation of the two parties is also analyzed to better derive how the performance of the system is influenced by the parties and their interactions as well. Then, this study illustrates the proposed models and effective incentive contracts by applying them to the efficiency evaluations of 22 China listed electric power companies.
Equity Based Incentives (“EBIs”) remain the dominant form of incentives in many developed and developing countries; and thus have significant effects on the quality-of-life and subjective well-being of individuals in both small and large firms. The timing of exercise of EBIs and the associated legal and economic ramifications have generated substantial debate. This article: i) critiques existing academic thought on information (disseminated primarily through the Internet) and exercise of employees’ incentive contracts within the context of industry competition, ii) shows how Equity-Based Incentives (“EBIs”) cause information asymmetry, and vice versa (even with substantial Internet access/penetration), iii) introduces the optimal conditions for exercise of EBIs by ‘insiders’ in an era of Internet access; and introduces new methods/conditions to control the monetization of EBIs by executives/employees; and introduces new distribution-free methods/models for the prediction and prevention of the monetization of EBIs; and these models can incorporate estimates of future states of the subject company, behavior patterns (of investors and employees) and the Stock markets and some of the conditions introduced herein are or can be transformed into alternative risk premia strategies; iv) explains how the option exercise decision is part of, and affects capital budgeting decisions of firms; v) applies MN-Transferable-Utility, and introduces the “Flexible Utility Framework” which implicitly assigns a dynamic utility function to specific instances; vi) introduces a new distribution-free approach to modeling risk and behavior. Most of the monetization of EBIs is executed with swaps, forward contracts, futures contracts, Indexed Annuities, equity-linked Annuities, regular loans and insured loans that are secured with EBIs. The analysis of optimal exercise of EBIs may help in formulation of appropriate policies for taxation of EBIs, regulation of securities markets, employee compensation and regulation of competition.
Healthcare reimbursements in the United States have been traditionally based on a fee-for-service (FFS) scheme, providing incentives for high volume of care, rather than efficient care. The new healthcare legislation tests new payment models that remove such incentives, such as the bundled payment (BP) system. We consider a population of patients (beneficiaries). The provider may reject patients based on the patient’s cost profile and selects the treatment intensity based on a risk-averse utility function. Treatment may result in success or failure, where failure means that unforeseen complications require further care. Our interest is in analyzing the effect of different payment schemes on outcomes such as the presence and extent of patient selection, the treatment intensity, the provider’s utility and financial risk, and the total system payoff. Our results confirm that FFS provides incentives for excessive treatment intensity and results in suboptimal system payoff. We show that BP could lead to suboptimal patient selection and treatment levels that may be lower or higher than desirable for the system, with a high level of financial risk for the provider. We also find that the performance of BP is extremely sensitive to the bundled payment value and to the provider’s risk aversion. The performance of both BP and FFS degrades when the provider becomes more risk averse. We design two payment systems, hybrid payment and stop-loss mechanisms, that alleviate the shortcomings of FFS and BP and may induce system optimum decisions in a complementary manner.
This paper was accepted by Serguei Netessine, operations management.
This paper presents a novel approach to the problem of infrastructure development by integrating technical, economic and operational aspects, as well as the interactions between the entities who jointly carry out the project. The problem is defined within the context of a Public Private Partnership (PPP), where a public entity delegates the design, construction and maintenance of an infrastructure system to a private entity. Despite the benefits of this procurement method, the relationship between the two entities is inherently conflictive. Three main factors give rise to such conflict: the goals of the public and private party do not coincide, there is information asymmetry between them and their interaction unfolds in environments under uncertainty. The theory of contracts refers to this problem as a principal-agent problem; however, due to the complexity of the problem, it is necessary to recreate a dynamic interaction between the principal (i.e., the public entity) and the agent (i.e., the private entity) while including the monitoring of the infrastructure performance as an essential part of the interaction. The complex relationship between the sequential actions of players and the time-dependent behavior of a physical system is explored using a hybrid agent-based simulation model. The model is illustrated with several examples that show the versatility of the approach and its ability to accommodate the different decision strategies of the players (i.e., principal, agent) and the model of a physical infrastructure system.
An important operational decision that a seller has to make is how to price his product under different situations. This dissertation addresses three unique pricing problems, commonly faced by a seller in a supply chain, in a series of three essays.
The first essay considers a supplier's problem of choosing which type of contracts to offer to a retailer whose demand forecasts can be improved over time. It is shown that there exist mechanisms which enable the supplier to always benefit from the retailer's improved demand forecasts. Such a mechanism consists of an initial contract, offered to the retailer before she obtains improved forecasts, and a later contract (contingent on the initial contract), offered to the retailer after she obtains improved forecasts.
The second essay investigates a retailer's problem of choosing which form of price promotions to offer to consumers, some of which are more inclined to increase spending when satisfied with the value of the deals. Two types of promotions are considered: i) all-unit discount, where a price reduction applies to every unit of a purchase that meets the minimum requirement, and ii) fixed-amount discount, where the final amount that a consumer has to pay is reduced by a predetermined discount amount if the purchase meets the minimum requirement. It is shown that both discount schemes can induce consumers to overspend. However, depending on consumer valuation of the product, one scheme can be more profitable to the retailer than the other.
The third essay discusses a dual-channel retailer's problem of choosing a price differentiating policy (charging different prices for the same product sold at different channels) and/or inventory transshipping policy (transferring inventory between the channels) to balance available inventory and demand arriving at each channel. It is shown that the two mechanisms have different implications on sales volume. Which mechanism is more effective depends on the retailer's initial inventory position. Furthermore, when implemented concurrently, the benefit from price differentiation and inventory transshipment mechanisms may either substitute or complement each other.
We analyze the equilibrium of an incomplete information game consisting of two capacity-constrained suppliers and a single retailer. The capacity of each supplier is her private information. Conditioned on their capacities, the suppliers simultaneously and noncooperatively offer quantity-price schedules to the retailer. Then, the retailer decides on the quantities to purchase from each supplier to maximize his own utility. We prove the existence of a (pure strategy) Nash equilibrium for this game. We show that at the equilibrium each (infinitesimal) unit of the supply is assigned a marginal price that is independent of the capacities and depends only on the valuation function of the retailer and the distribution of the capacities. In addition, the supplier with the larger capacity sells all her supply.
All products and systems are unreliable in the sense that they degrade and fail. Corrective maintenance (CM) restores a failed item to an operational state and effective preventivemaintenance (PM) reduces the likelihood of failure. Thesemaintenance actions can be done either in-house or can be outsourced to an external agent. We focus on the maintenance being outsourced and look at the issues involved from the perspectives of the owner of the asset and the agent providing the maintenance service.
We consider a supply chain in which a distributor procures from a manufacturer a type of fresh product, which has to undergo long distance transportation before reaching the market. In addition to the risk caused by random fluctuations of the market demand, the distributor also faces the risk that the product procured may decay and deteriorate during transportation. The market demand for the product depends on its level of freshness and the distributor’s selling price. The manufacturer has to determine his wholesale price based on its effect on the order quantity of the distributor, whereas the distributor has to determine his order quantity and selling price, based on the wholesale price, the likely loss of the product in long distance transportation, the product’s level of freshness when it reaches the market, and the possible demand for the product. We develop a model to formulate this problem, and derive each party’s optimal decisions in both uncoordinated and coordinated situations. We introduce a new incentive scheme to facilitate the coordination of the two parties, which comprises two parts: (1) the manufacturer offers his wholesale price as a function of the actual transportation time and price discount in the market; and (2) the manufacturer compensates the distributor for any unsold unit of the product. We show that this incentive scheme can induce the distributor to order up to the quantity required to maximize the total benefit of the centralized system, and both parties will all be better off than in the uncoordinated case. Computational studies are also conducted, which reveal some interesting managerial insights.
Sustainable animal disease management requires to design and implement control policies at the regional scale. However, for diseases which are not regulated, individual farmers are responsible for the adoption and successful application of control policies at the farm scale. Organizations (groups of farmers, health institutions...) may try to influence farmers' control actions through financial incentives, in order to ensure sustainable (from the health and economical point of views) disease management policies. Economics / Operations Research frameworks have been proposed for modeling the effect of incentives on agents. The Leader-Follower Markov Decision Processes framework is one such framework, that combines Markov Decision Processes (MDP) and stochastic games frameworks. However, since finding equilibrium policies in stochastic games is hard when the number of players is large, LF-MDP problems are intractable. Our contribution, in this article, is to propose a tractable model of the animal disease management problem. The tractable model is obtained through a few simple modeling approximations which are acceptable when the problem is viewed from the organization side. As a result, we design a polynomial-time algorithm for animal disease management, which we evaluate on a case study inspired from the problem of controlling the spread of the Porcine Reproductive and Respiratory Syndrome (PRRS). Copyright © 2013, Association for the Advancement of Artificial Intelligence (www.aaai.org). All rights reserved.
The Quantity Flexibility (QF) contract is a method for coordinating materials and information flows in supply chains operating under rolling-horizon planning. It stipulates a maximum percentage revision each element of the period-by-period replenishment schedule is allowed per planning iteration. The supplier is obligated to cover any requests that remain within the upside limits. The bounds on reductions are a form of minimum purchase commitment which discourages the customer from overstating its needs. While QF contracts are being implemented in industrial practice, the academic literature has thus far had little guidance to offer a firm interested in structuring its supply relationships in this way. This paper seeks to address this need, by developing rigorous conclusions about the behavioral consequences of QF contracts, and hence about the implications for the performance and design of supply chains with linkages possessing this structure. Issues explored include the impact of system flexibility on inventory characteristics and the patterns by which forecast and order variability propagate along the supply chain. The ultimate goal is to provide insights as to where to position flexibility for the greatest benefit, and how much to pay for it.
In this paper, the author summarizes four new strands in agency theory that help him think about incentives in real organizations. As a point of departure, The author begins with a quick sketch of the classic agency model. He then discusses static models of objective performance measurement that sharpen Kerr's argument; repeated-game models of subjective performance assessments; incentives for skill development rather than simply for effort; and incentive contracts between versus within organizations. The author concludes by suggesting two avenues for further progress in agency theory: better integration with organizational economics, as launched by Coase (1937) and reinvigorated by Williamson (1975, 1985), and cross-pollination with other fields that study organizations, including industrial relations, organizational sociology, and social psychology. Copyright 1998 by American Economic Association.
This paper constructs a model of saving for retired single people that includes heterogeneity in medical expenses and life expectancies, and bequest motives. We estimate the model using Assets and Health Dynamics of the Oldest Old data and the method of simulated moments. Out-of-pocket medical expenses rise quickly with age and permanent income. The risk of living long and requiring expensive medical care is a key driver of saving for many higher-income elderly. Social insurance programs such as Medicaid rationalize the low asset holdings of the poorest but also benefit the rich by insuring them against high medical expenses at the ends of their lives. (c) 2010 by The University of Chicago. All rights reserved..
This book provides a comprehensive overview of how to strategically manage the movement and storage of products or materials from any point in the manufacturing process to customer fulfillment. Topics covered include important tools for strategic decision making, transport, packaging, warehousing, retailing, customer services and future trends. An introduction to logistics Provides practical applications Discusses trends and new strategies in major parts of the logistic industry.
Most important decision problems-virtually all capital investiments and planning situations-involve risky cash flows with uncertainties that are resolved over time. In most of these problems, the decision-maker has access to financial markets and may borrow and lend to smooth consumption over time. Yet, because of the difficulty of incorporating these borrowing and lending decisions into the evaluation models, these opportunities are rarely explicitly modeled in decision and risk analyses of these investments. In this paper, we study the errors induced by failing to account for these borrowing and lending decisions, and we develop extensions to the standard decision and risk analysis procedures that, given certain market and preference assumptions, take these borrowing and lending opportunities into account without overburdening the evaluation models.
This textbook aims to provide a comprehensive overview of the essentials of microeconomics. It offers unprecedented depth of coverage, whilst allowing lecturers to 'tailor-make' their courses to suit personal priorities. Covering topics such as noncooperative game theory, information economics, mechanism design and general equilibrium under uncertainty, it is written in a clear, accessible and engaging style and provides practice exercises and a full appendix of terminology.
This paper considers a health-care delivery system with two noncooperative parties: a purchaser of medical services and a specialized provider. A dynamic principal-agent model that captures the interaction between the two parties is developed. In this model, patients arrive exogenously, receive periodic treatment from the provider, suffer costly complications that require hospital care, and eventually exit the system in death. The provider chooses the intensity of treatment in each period, incurs an associated cost, and is reimbursed by the purchaser according to observed patient outcomes. The purchaser's problem is to determine a payment system that will induce treatment choices maximizing total social welfare. The optimal payment system, referred to as the outcomes-adjusted payment system, is identified. It consists of a prospective payment per patient and a retrospective payment adjustment based on adverse short-term patient outcomes. This system induces the most efficient delivery of medical services by combining the immediate "threat" of a retrospective payment adjustment with the future reward of prospective payments generated by surviving patients. A numerical example is provided in the context of Medicare's End-Stage Renal Disease program. The example compares the optimal system to systems that are currently in place. The results suggest that the purchaser can achieve significant gains in patient life expectancy by switching to the outcomes-adjusted payment system, but this requires accurate information about treatment technology, patient characteristics, and provider preferences. The life-expectancy gains do not involve increased medical expenditures.
Stereotypically, marketing is mainly concerned about satisfying customers and manufacturing is mainly interested in factory efficiency. Using the principal-agent (agency) paradigm, which assumes that the marketing and manufacturing managers of the firm will act in their self-interest, we seek incentive plans that will induce those managers to act so that the owner of the firm can attain as much as possible of the residual returns. One optimal incentive plan can be interpreted as follows: The owner subcontracts to pay the manufacturing manager a fixed rate for all capacity he delivers. Each marketing manager receives all of the returns from his product. In turn, all managers pay a fixed fee to the owner. Under this plan, the marketing managers will often complain about the stock level decisions, even though these levels are announced in advance. Under a revised plan, the owner can eliminate such complaints by delegating the stocking decisions to the respective marketing managers, without any loss. This plan is interpreted as requiring the owner to make a futures market for manufacturing capacity, paying the manufacturing manager the expected marginal value for each unit of capacity delivered, receiving the realized marginal value from the marketing managers, and losing money on average in the process.
In this paper, we describe an analytical model to determine contracting policies for a firm that purchases components from external suppliers. The model evaluates the tradeoff between the flexibility offered by short term contracts and the fixed investments, improvement opportunities and price certainty associated with long term contracts. We show that long term contracts may not always be optimal, and discuss conditions under which short term contracts may be justified. During a recent survey of supply managers, we observed that managers often tend to participate in short term contracts, even though they claim to seek long term relationships with suppliers. Sensitivity analysis of our model provides some explanation for this observed inconsistency. We also discuss managerial implications of the analysis.
Lot streaming is the process of splitting a job or lot to allow overlapping between successive operations in a multistage production system. This use of transfer lots usually results in a significantly shorter makespan for the schedule. We study the structural properties of schedules which minimize the makespan for a single job with attached setup times in a flow shop. The structure of the optimal schedules is more complex than in the case with no setups or detached setups, as it may follow a much larger variety of patterns. Using the structural insights obtained, however, it is possible to find the optimal solution with s sublots in O(s) time for the three-machine case.
Long-term contracts are valuable only if optimal contracting requires commitment to a plan today that would not otherwise be adopted tomorrow. We show that commitments are unnecessary, and hence short-term contracts are sufficient if (1) all public information can be used in contracting, (2) the agent can acess a bank on equal terms with the principal, (3) recontracting takes place with common knowledge about technology and preferences and (4) the frontier of expected utility payoffs generated by the set of incentive-compatible contracts is downward sloping at all times.
In this article, the authors examine theoretically the use of benchmark portfolios in the compensation of privately informed portfolio managers. They find that the use of a benchmark, and particularly the types of benchmarks often observed in practice, cannot be easily rationalized. Specifically, commonly used benchmark-adjusted compensation schemes are generally inconsistent with optimal risk-sharing and do not lead to the choice of an optimal portfolio for the investor. Moreover, benchmarks do not help in solving potential contracting problems such as inducing the manager to expend effort or trying to screen out uninformed managers. Copyright 1997 by University of Chicago Press.
The role of imperfect information in a principal-agent relationship subject to moral hazard is considered. A necessary and sufficient condition for imperfect information to improve on contracts based on the payoff alone is derived, and a characterization of the optimal use of such information is given.
This paper was presented at the World Congress of the Econometric Society, Cambridge, Massachusetts, 1985
In this paper, we analyze optimal contracts in an infinitely repeated agency model in which both the principal and agent discount
the future. We show that there is a stationary representation of the optimal contract when the agent's conditional discounted
expected utility is used as a state variable. This representation reduces the multi-period problem to a static variational
problem which can be analyzed using standard variational techniques. This reduction is used to obtain several properties of
the contract.
The authors develop two themes in the theory of incentive schemes. First, one need not always use all of the information available in an optimal incentive contract. Accounting information, which aggregates performance over time, is sufficient for optimal compensation schemes in certain classes of environments. Second, optimal rules in a rich environment must work well in a range of circumstances and cannot, therefore, be complicated functions of the observed outcome. The authors illustrate these ideas in a particular model where the agent has a rich space of controls, showing that the unique optimal compensation scheme is a linear function of profits. Copyright 1987 by The Econometric Society.
In a repeated principal-agent game (supergame) in which each player's criterion is his long-run average expected utility, efficient behavior can be sustained by a Nash equilibrium if it is pareto-superior to a one-period Nash equilibrium. Furthermore, if the players discount future expected utilities, then for every positive epsilon, and every pair of discount factors sufficiently close to unity (given epsilon), there exists a supergame equilibrium that is within epsilon (in normalized discounted expected utility) of the target efficient behavior. These supergame equilibria are explicitly constructed with simple "review strategies."
Incentive problems in oil and gas shelter programs Zeckhauser eds. Principals and Agents: The Structure of Business
- M Wolfson
Wolfson, M. 1985. Incentive problems in oil and gas shelter programs. J. W. Pratt and R. J. Zeckhauser eds. Principals and
Agents: The Structure of Business. Harvard Business School Press,
Boston, MA.
Modeling supply chain contracts: A review Quantitative Models for Supply Chain Management
- A A Tsay
- S Nahmias
Tsay, A. A., S. Nahmias, N. Agrawal. 1998. Modeling supply chain
contracts: A review. S. Tayur, M. Magazine, R. Ganeshan, eds.
Quantitative Models for Supply Chain Management. Kluwer Academic Publishers, Norwell, MA. 299–336.
The theory of contracts Advances in Economic Theory Fifth World Congress
- O Hart
- B Holmstrom
Hart, O., B. Holmstrom. 1987. The theory of contracts. T. F. Bewley,
ed. Advances in Economic Theory Fifth World Congress. Cambridge University Press, Cambridge, UK. 97–103.
The provision of incentives in firms. Working Paper, The University of Chicago Graduate School of Business
- C Prendergast
Prendergast, C. 1998. The provision of incentives in firms. Working
Paper, The University of Chicago Graduate School of Business,
Chicago, IL.