Reference points and the tradeoff between risk and incentives

Thomas Dohmen, Arjan Rotterdam, Tom Stolp

Research output: Working paper / PreprintDiscussion paper


We conduct laboratory experiments to investigate basic predictions of principal-agent theory about the choice of piece rate contracts in the presence of output risk, and provide novel insights that reference dependent preferences affect the tradeoff between risk and incentives. Subjects in our experiments choose their compensation for performing a real-effort task from a menu of linear piece rate and fixed payment combinations. As classical principal-agent models predict, more risk averse individuals choose lower piece rates. However, in contrast to those predictions, we find that low-productivity risk averse workers choose higher piece rates when the riskiness of the environment increases. We hypothesize that reference points affect piece rate choice in risky environments, such that individuals whose expected earnings would exceed (fall below) the reference point in a risk-free environment behave risk averse (seeking) in risky environments. In a second experiment, we exogeno usly manipulate reference points and confirm this hypothesis.
Original languageEnglish
Place of PublicationBonn
Number of pages46
Publication statusPublished - 2021

Publication series

SeriesIZA Discussion Paper Series

JEL classifications

  • d81 - Criteria for Decision-Making under Risk and Uncertainty
  • d91 - "Intertemporal Consumer Choice; Life Cycle Models and Saving"
  • m52 - Personnel Economics: Compensation and Compensation Methods and Their Effects


  • incentive
  • piece-rate
  • risk
  • reference point
  • laboratory experiment

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