To induce an agent to work hard, a principal may offer the agent a bonus, in other words, an extra payment if a performance target is hit. Suppose that the agent’s performance is affected by factors beyond the agent’s control, for example umbrellas are demanded more on a rainy day. Under what conditions may the bonus not induce the agent to work harder?

A) The agent is very risk averse.
B) The principal is risk neutral
C) The agent is risk neutral.
D)  The agent is very risk loving.

ANSWER:

A) The agent is very risk averse.