Dynamic Contracting: Accidents Lead to Nonlinear Contracts (original) (raw)
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Linear Contracts and the Double Moral-Hazard ¤ We would like to thank
This paper studies the characteristics of optimal contracts when the agent is riskaverse in the double moral-hazard situation in which the principal also participates in the production process. It is already known that a simple linear contract is one of many optimal contracts under the double moral-hazard when the agent is risk-neutral. We …nd that the agent's optimal incentive scheme in this case is unique and non-linear, but less sensitive to output than would be designed under a single moral-hazard. We also …nd that the linear contract is not robust in the sense that the above unique and non-linear contract does not approach the linear contract as the agent's risk-aversion approaches zero.
The Threat of Insurance On the Robustness of Principal-Agent Models
2001
The traditional principal-agent model assumes that the principal offers an exclusive contract to the agent. This paper shows that the standard results are not robust to the introduction of additional contracting opportunities for the agent. We analyze equilibria of an extended game with the presence of additional players who might trade risk away from the agent. There are settings (and parameter values) in which the principal is worse off, total welfare is lower, and suboptimal effort is implemented in equilibrium. There are other settings in which the principal can manage to be as well off as in the standard case, but in these cases he has to offer a steeper contract for performance. These findings may call for a revision of some previous theoretical and applied conclusions.
Dynamic Contracts with Moral Hazard and Adverse Selection
The Review of Economic Studies, 2012
We study a novel dynamic principal-agent setting with moral hazard and adverse selection (persistent as well as repeated). In the model an agent whose skills are his private information faces a finite sequence of tasks, one after the other. Upon arrival of each task the agent learns its level of difficulty and then chooses whether to accept or refuse each task in turn, and how much effort to exert. Although his decision to accept or refuse a task is publicly known, the agent's effort level is his private information.
Principal-Agent Contracts under the Threat of Insurance
Journal of Institutional and Theoretical Economics, 2007
The traditional principal-agent model assumes that the principal offers an exclusive contract to the agent. This paper shows that the standard results are not robust to the introduction of additional contracting opportunities for the agent. We analyze equilibria of an extended game with the presence of additional players who might trade risk away from the agent. The contract offered by the principal in order to elicit high effort is steeper than in the standard model. In some settings, the agent accepts this contract and then unwinds part of those incentives through additional trades. (This seems consistent with some findings in the literature on managerial compensation). For some settings and parameter values, suboptimal effort is implemented in equilibrium, the principal is worse off, and total welfare is lower. These findings may call for a revision of some previous theoretical and applied conclusions. In designing compensation schemes, attention should be paid to outside opportunities, even when they are productively unrelated. Some results such as "the Informativeness Principle" might need to be reformulated to consider the observability of signals by the principal relative to their observability by other potential traders.
Multitasking, Multidimensional Screening, and Moral Hazard with Risk Neutral Agents*
Economic Record, 2010
In this paper we consider a model where a risk-neutral principal devises a contract for a risk neutral agent who can exert effort along different dimensions and possesses private information about her cost of effort. We show that when the number of effort dimensions exceeds the number of performance measures observed by the principal hidden action leads to an additional welfare loss compared with pure adverse selection even if both parties are risk neutral and the production technology is independent of the agent's type. The result implies that if effort has many dimensions it is beneficial to the principal to base employees' compensation on many performance measures rather than on a single 'bottomline' measure (e.g. their contribution to the company's profits).
Repeated Moral Hazard with Costly Self Control
SSRN Electronic Journal
We consider a repeated principal-agent model, where a single agent exhibits problems of self control modelled using Gul and Pesendorfer (2001) type temptation preferences. In such a setting, for a parameterized strength of self-control, we solve for the optimal multi-period contract. Our analysis identifies a new channel of principal and agent interactions, that can be used to provide incentives, this being the reduction of agent's self control costs. In fact, the principal computes (and uses) agent's most tempting item but never finds it optimal to reduce the agent's self-control cost to zero. Presence of this new channel challenges typical results obtained in models with no-temptation on the agent's side. For example, the intrinsic motivation (resulting from costly self-control) can substitute for standard (external) incentives, and hence the moral hazard problem can be mitigated (for sufficiently high temptation parameter). Moreover, the optimal contract calls for a lower deferred part of the bonus (or consumption smoothing) than in the model with no temptations. Under limited commitment, presence of self-control also reduces agent's willingness to break or renegotiate the contract after output realization within some period, and make the optimal contract spot implementable (again for sufficiently high temptation). Impact of self-control on the cost of implementation as well as willingness to safe/borrow is ambiguous, however.
Optimal Assignment of Liabilities
I characterize a generalization of the negligence rule to assign compensating damages in an accident involving multiple tortfeasors. These tortfeasors have the opportunity to undertake spending in prevention and the rule is designed to provide them with the best incentives to do so. I study the case where liability is constraint in the sense that the optimal amount of effort (not constrained by liability) cannot be implemented. The optimal multi-player rule is to apply the negligence rule to the most liable player (the "deep-pocket" or the "victim", defined as the player who is the most responsive to monetary incentives under the strict liability rule) and the strict liability rule to everybody else.
Multitasking, Multidimensional Screening, and Moral Hazard with Risk Neutral Agents &ast
Economic Record, 2010
In this paper we consider a model where a risk-neutral principal devises a contract for a risk neutral agent who can exert effort along different dimensions and possesses private information about her cost of effort. We show that when the number of effort dimensions exceeds the number of performance measures observed by the principal hidden action leads to an additional welfare loss compared with pure adverse selection even if both parties are risk neutral and the production technology is independent of the agent's type. The result implies that if effort has many dimensions it is beneficial to the principal to base employees’ compensation on many performance measures rather than on a single ‘bottom-line’ measure (e.g. their contribution to the company's profits).
Economic Record, 2010
In this paper we consider a model where a risk-neutral principal devises a contract for a risk neutral agent who can exert effort along different dimensions and possesses private information about her cost of effort. We show that when the number of effort dimensions exceeds the number of performance measures observed by the principal hidden action leads to an additional welfare loss compared with pure adverse selection even if both parties are risk neutral and the production technology is independent of the agent's type. The result implies that if effort has many dimensions it is beneficial to the principal to base employees’ compensation on many performance measures rather than on a single ‘bottom-line’ measure (e.g. their contribution to the company's profits).
Risk Aversion, Liability Rules, and Safety
International Review of Law and Economics, 2005
This paper investigates the performance of liability rules in two-party stochastic externality problems where negotiations are feasible and side payments are based on the realized level of externalities. Results show that an increase in polluter liability does not necessarily increase safety or efficiency in cases where the polluter is risk neutral. Complete polluter liability is found to yield Pareto optimality. When either party is risk averse, an increase in polluter liability may sometimes reduce safety and efficiency. If the polluter is risk neutral and the victim is risk averse, Pareto optimality is only achieved by assigning full liability on the polluter, i.e. giving the victim complete property rights to a clean environment. If the polluter is risk averse and the victim is risk neutral, no level of polluter liability is optimal. In this case, optimality can only be achieved through a contract on abatement activities, such that the risk-averse polluter receives a guaranteed payment regardless of the stochastic outcome.