Inducing Leaders to Take Risky Decisions: Dismissal, Tenure, and Term Limits

Abstract

How can a principal (employer or voter) induce an agent (worker or politician) to choose the “right” actions if risky actions reveal the agent's decision-making competence and only dismissal can be used as an incentive instrument? We first show that if the principal can commit to a replacement strategy, then optimal mechanisms involve either (i) a probationary period and then indefinite tenure, or (ii) dismissing poorly performing agents but also randomly replacing agents who take nonrevealing actions. When the principal cannot commit, incentives can be improved by imposing term limits on agents. (JEL D72, D82, M51)