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First-Order Approach to Principal-Agent Problems: A Generalization

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  • Eskander Alvi

    (Department of Economics, Western Michigan University, Kalamazoo MI 49008.)

Abstract

The first-order approach (FOA) to principal agent problems is very convenient and mathematically tractable. However, existing results show that the FOA is valid only for additively separable utility functions. This is somewhat limiting. In this article sufficient conditions are identified that extend the validity of the FOA to nonseparable cases. The additional conditions involve restrictions on the agent's preferences, particularly interactions between action and the wage contract. These conditions imply that leisure is normal and the agent's absolute risk aversion increases with action. Comparative static results regarding the wage contract and its gradient are also discussed. The Geneva Papers on Risk and Insurance Theory (1997) 22, 59–65. doi:10.1023/A:1008663531322

Suggested Citation

  • Eskander Alvi, 1997. "First-Order Approach to Principal-Agent Problems: A Generalization," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 22(1), pages 59-65, June.
    • Handle: RePEc:pal:genrir:v:22:y:1997:i:1:p:59-65
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    Cited by:

    1. Jung, Jin Yong & Kim, Son Ku, 2015. "Information space conditions for the first-order approach in agency problems," Journal of Economic Theory, Elsevier, vol. 160(C), pages 243-279.
    2. Thiele, Henrik & Wambach, Achim, 1999. "Wealth Effects in the Principal Agent Model," Journal of Economic Theory, Elsevier, vol. 89(2), pages 247-260, December.
    3. Kirkegaard, René, 2017. "A unifying approach to incentive compatibility in moral hazard problems," Theoretical Economics, Econometric Society, vol. 12(1), January.
    4. Jukka Pirttilä & Matti Tuomala, 2007. "Labour income uncertainty, taxation and public good provision," Economic Journal, Royal Economic Society, vol. 117(518), pages 567-582, March.
    5. Anyangah, Joshua O., 2017. "Creditor rights protection, tort claims and credit," International Review of Law and Economics, Elsevier, vol. 52(C), pages 29-43.
    6. Dominique Henriet & Patrick A. Pintus & Alain Trannoy, 2014. "Is the Flat Tax Optimal under Income Risk?," Working Papers halshs-00999222, HAL.
    7. Fagart, Marie-Cécile & Fluet, Claude, 2013. "The first-order approach when the cost of effort is money," Journal of Mathematical Economics, Elsevier, vol. 49(1), pages 7-16.
    8. Edward Simpson Prescott, 1999. "A primer on moral-hazard models," Economic Quarterly, Federal Reserve Bank of Richmond, issue Win, pages 47-78.
    9. Xianhua Dai, 2011. "Optimal Taxation under Income Uncertainty," Annals of Economics and Finance, Society for AEF, vol. 12(1), pages 121-138, May.

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