Moral Hazard with Limited Liability

Moral Hazard with Limited Liability
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.

Optimal Tenurial Contracts Under Both Moral Hazard and Adverse Selection

Optimal Tenurial Contracts Under Both Moral Hazard and Adverse Selection
Author: Christian At
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Total Pages: 0
Release: 2020
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This paper determines the optimal tenurial contract between a monopoly landlord and a tenant protected by limited liability under both adverse selection (based on the tenant's ability) and moral hazard (based on the tenant's choice of effort). We identify different optimal contracts depending on the tenant's outside option. For intermediate values, there is a threshold of tenant ability depending on the outside option level below which the optimal contract is a separating sharecropping contract, and a pooling one otherwise. We also find that an increase in the outside option does not monotonically increase the tenant's optimal effort.

Contracting with Moral Hazard, Adverse Selection and Risk Neutrality

Contracting with Moral Hazard, Adverse Selection and Risk Neutrality
Author: Felipe Balmaceda
Publisher:
Total Pages: 41
Release: 2018
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This paper studies a principal-agent model in which the principal and agent are risk-neutral, there are two actions, adverse selection, moral hazard and limited liability. When the two actions are subject to moral hazard, there is no distortion at the top, the optimal action profile is downward distorted for everyone else and the optimal menu of contract exhibits the one-size-fits-all property; that is, each ability type receives the same contract. The optimal contract pays a bonus when the outcome with the highest likelihood ratio is observed and the limited liability otherwise. When one of the actions is contractible and the other is subject to moral hazard, there is no distortion at the top, the non-contractible action is downward distorted for everyone else, the contractible action can be either upward or downward distorted. The optimal contract no longer exhibits the one-size-fits-all property. The one-size-fits-all property sheds light why we rarely observe menus of contracts in market that use franchising, credit and labor markets, and in regulated industries.

Simple Contracts with Adverse Selection and Moral Hazard

Simple Contracts with Adverse Selection and Moral Hazard
Author: Daniel Gottlieb
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Total Pages: 0
Release: 2015
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We study a principal-agent model with both moral hazard and adverse selection. Risk-neutral agents with limited liability have arbitrary private information about the distribution of outputs and the cost of effort. We obtain conditions under which the optimal mechanism offers a single contract to all types. These conditions are always satisfied, for example, if output is binary or if the distribution of outputs is multiplicatively separable and ordered by FOSD (if it is not ordered, the optimal mechanism offers at most two contracts). If, in addition, the marginal distribution satisfies the monotone likelihood ratio property, this single contract is a debt contract. Our model suggests that offering a single contract may be optimal in environments with adverse selection and moral hazard, where offering flexible menus of contracts provides gaming opportunities to the agent.

Optimal Wage Contracts Under Asymmetric Information and Moral Hazard When Investment Decisions are Delegated

Optimal Wage Contracts Under Asymmetric Information and Moral Hazard When Investment Decisions are Delegated
Author: C. N. V. Krishnan
Publisher:
Total Pages: 18
Release: 2004
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In this paper, I derive the optimal wage contract when risky investment decisions are delegated by a risk-averse firm to risk-neutral agents. The firm does not know the probability distribution over the returns of any investment made by an agent. It knows only the first two moments and the bounds of return realizations of the different positive NPV investment opportunities that can be discovered by the agents. Moral hazard with respect to investments made by agents, who are protected by limited liability, is possible. I show that the optimal wage contract is simple under conditions of severe asymmetric information and moral hazard.