Equilibria in Budget Participation

The article discusses Pareto-optimality in budget-based incentive systems for executive compensation and the principle-agent relationship where the business owner is the principle and the manager is the agent. Utility functions illustrate the effect of different budget models on a manager's behavior and the owner's expected payoff, as well as the role of uncertainty and value of knowing local conditions when estimating profitability. The budget participation game and equilibrium problem refers to the acceptance of a manager's report on local conditions as being accurate and not "padded." Probability functions for two participation games are explained. How the budget-based incentive scheme is less effective than profit-sharing when the agent is risk-neutral is mentioned.