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The moral hazard problem with high stakes

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  • Chade, Hector
  • Swinkels, Jeroen

Abstract

We study the moral-hazard problem when the agent's reservation utility is large, but so is the agent's value to the principal. We show that the principal's cost of implementing effort has a very simple limiting form. For large enough outside option, the principal's cost is convex in the action, so the optimally-implemented action is unique, and optimal effort rises with the agent's ability, and falls with the agent's wealth and outside option. In a competitive market setting where heterogenous principals and agents match, positive sorting ensues and effort increases in match quality, despite conflicting forces.

Suggested Citation

  • Chade, Hector & Swinkels, Jeroen, 2020. "The moral hazard problem with high stakes," Journal of Economic Theory, Elsevier, vol. 187(C).
    • Handle: RePEc:eee:jetheo:v:187:y:2020:i:c:s0022053120300363
    DOI: 10.1016/j.jet.2020.105032
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    References listed on IDEAS

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    Cited by:

    1. Antonio Díaz & Francisco Jareño & Eliseo Navarro, 2022. "Yield curve data choice and potential moral hazard: An empirical exercise on pricing callable bonds," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 27(2), pages 2124-2145, April.
    2. Silvia Martinez-Gorricho & Miguel Sanchez Villalba, 2021. "Incentives, ability and disutility of effort," SERIEs: Journal of the Spanish Economic Association, Springer;Spanish Economic Association, vol. 12(3), pages 453-487, September.

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    More about this item

    Keywords

    Moral hazard; First-order approach; Principal-agent problem; Comparative statics; Matching;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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