Gaming and Strategic Ambiguity in Incentive Provision

A central tenet of economics is that people respond to incentives. While an appropriately crafted incentive scheme can achieve the second-best optimum in the presence of moral hazard, the principal must be very well informed about the environment (e.g., the agents preferences and the production technology) in order to achieve this. Indeed, it is often suggested that incentive schemes can be gamed by an agent with superior knowledge of the environment, and furthermore that lack of transparency about the nature of the incentive scheme can reduce gaming. We provide a formal theory of these phenomena. We show that ambiguous incentive schemes induce more balanced e¤orts from an agent who performs multiple tasks and who is better informed about the environment than the principal is. On the other hand, such ambiguous schemes impose more risk on the agent per unit of e¤ort induced. By identifying settings in which ambiguous schemes are especially e¤ective in inducing balanced e¤orts, we show that, if tasks are su ¢ ciently complementary for the principal, ambiguous incentive schemes can dominate the best deterministic scheme and can completely eliminate the e ¢ ciency losses from the agents better knowledge of the environment. (JEL L13, L22)