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Moral hazard and compensation packages: does reshuffling matter?

Author

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  • Alessandro Fedele

    (Free University of Bolzano)

  • Luca Panaccione

    (University of Rome Tor Vergata)

Abstract

We study a moral hazard model in which the agent receives a compensation package made up of multiple commodities. We allow for the possibility that commodities are traded on the market and consider two scenarios. When trade in commodities is verifiable, the agent cannot reshuffle the compensation package prescribed by the principal and simply selects the hidden action which is optimal given that package. When trade in commodities is, instead, not verifiable, the agent can reshuffle the prescribed package by trading it for another one and can select a different action. We prove that an optimal contract (i.e., a contract which maximizes the principal’s expected payoff) when trade is verifiable remains optimal when trade is not verifiable if agent’s preferences for commodities are independent of the action performed. When, instead, preference independence fails, we show it is always possible to find prices of commodities such that an optimal contract under trade verifiability cannot be optimal under nonverifiability.

Suggested Citation

  • Alessandro Fedele & Luca Panaccione, 2020. "Moral hazard and compensation packages: does reshuffling matter?," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 70(1), pages 223-241, July.
    • Handle: RePEc:spr:joecth:v:70:y:2020:i:1:d:10.1007_s00199-019-01208-5
    DOI: 10.1007/s00199-019-01208-5
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    References listed on IDEAS

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    More about this item

    Keywords

    Moral hazard; Compensation packages; Reshuffling; Independent preferences;
    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
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods

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