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Moral Hazard and Limited Liability

Author

Listed:
  • Jacques Lawarree

    (University of Washington)

  • Marc van Audenrode

    (Universite Laval)

Abstract

Real world contracts limit the liabilities of agents by imposing constraints on their transfers or on their utilities. In an adverse selection model, Sappington (1983) has shown that the two constraints yield an equivalent problem for the principal. We show that this result does not hold in a moral hazard framework. More specifically, we show that restrictions on the utilities are stronger in the sense that they yield a lower level of effort from the agent. Moreover, given an optimal contract constrained by a limited liability on utility, one can always find a Pareto dominating contract constrained by a limited liability on transfers.

Suggested Citation

  • Jacques Lawarree & Marc van Audenrode, 2000. "Moral Hazard and Limited Liability," Econometric Society World Congress 2000 Contributed Papers 0971, Econometric Society.
    • Handle: RePEc:ecm:wc2000:0971
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    References listed on IDEAS

    as
    1. Brander, James A & Spencer, Barbara J, 1989. "Moral Hazard and Limited Liability: Implications for the Theory of the Firm," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 30(4), pages 833-849, November.
    2. Innes, Robert D., 1990. "Limited liability and incentive contracting with ex-ante action choices," Journal of Economic Theory, Elsevier, vol. 52(1), pages 45-67, October.
    3. Macho-Stadler, Ines & Perez-Castrillo, J. David, 2001. "An Introduction to the Economics of Information: Incentives and Contracts," OUP Catalogue, Oxford University Press, edition 2, number 9780199243259.
    4. Sappington, David, 1983. "Limited liability contracts between principal and agent," Journal of Economic Theory, Elsevier, vol. 29(1), pages 1-21, February.
    5. Son Ku Kim, 1997. "Limited Liability and Bonus Contracts," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 6(4), pages 899-913, December.
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