Risk-taking incentives: A review of the literature

Incentive structures affect people's decisions. But what are the implications of the resulting choices that people make for the level of risk within the economy? This paper reviews the literature in this area and attempts to draw out practical work that can be taken forward in assessing risk-taking incentives in the UK. Understanding the principal-agent problem is key to explaining many of the incentive structures that emerge. The paper provides an exposition of this before considering its implications in the managerial and financial markets. Within both these markets the paper considers how incentive structures alter principals' behaviour, before considering possible solutions to the common problem of asymmetric information. The paper concludes that the implications for risk-taking are unclear, as incentive structures can lead to both increased and decreased risk-taking. It therefore makes a number of suggestions for future research into the effect of incentive structures in existence in the UK.