Moral Hazard With Limited Liability
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Author | : Wenbin Wang |
Publisher | : |
Total Pages | : 43 |
Release | : 2019 |
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This paper studies the optimal contract for a risk-neutral agency with limited liability. We introduce a novel formulation of the model, in which the contract design problem reduces to a problem of constructing the distribution function of a random variable. This formulation directly balances the principal's tradeoff between incentivizing the agent to exert proper effort and minimizing the cost of the agent's compensation. We show that the optimal contract may involve one or two tiers of performance-based bonuses. We obtain new sufficient conditions for the optimality of bonus contracts and provide new insights into the choice of contract parameters.
Author | : Jürgen Bierbaum |
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Total Pages | : 0 |
Release | : 2002 |
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This paper studies the incentives that arise in a two-period agency relationship with moral hazard when agents are subject to limited liability. Since the existence of limited liability creates rent the principal can motivate an agent by credibly threatening him to be fired. It is shown that a combination of a two-period contract, where the agent is fired after period one in case of poor performance and retained otherwise, and a one-period contract optimally implements high effort. In particular, this combination is strictly better than a two-period contract, where the agent is retained in period two for sure. Moreover, there is a combination of one-period contracts that is equivalent to the optimal combination. While the second-period contract is the same as the optimal contract in the static model, the first-period contract pays a lower bonus in case of success. In an extension of the model "learning by doing" is considered. It turns out that the ranking of contracts is reversed if the increase in revenues due to "learning by doing" is sufficiently strong. In addition, a commitment problem arises which makes short-term contracting strictly worse than long-term contracting.
Author | : Rohan Pitchford |
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Total Pages | : 18 |
Release | : 1997 |
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Release | : 2010 |
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Author | : Anindya Banerjee |
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Total Pages | : 48 |
Release | : 1988 |
Genre | : Credit control |
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Author | : Steven M. Matthews |
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Total Pages | : 21 |
Release | : 1999 |
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Author | : Susanne Ohlendorf |
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Total Pages | : 26 |
Release | : 2008 |
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Author | : Susanne Ohlendorf |
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Total Pages | : 0 |
Release | : 2008 |
Genre | : Limited liability |
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Author | : Steven A. Matthews |
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Total Pages | : 40 |
Release | : 1999 |
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Author | : Felipe Balmaceda |
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Total Pages | : |
Release | : 2019 |
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This article studies a principal-agent problem with discrete outcome and effort space. The principal and the agent are risk neutral and the latter is subject to limited liability. For a given monitoring technology, we consider the maximum possible ratio between the first best social welfare to the social welfare arising from the principal's optimal pay-for-performance contract (the price of unobservability). Our main results provide tight bounds for this price. Key parameters to these bounds are number of possible efforts, the likelihood ratio evaluated at the highest outcome, and the ratio between costs of the highest and the lowest efforts. The paper provides insights on how costly moral hazard and limited liability could be from the social point of view.