Overconfidence and ethical contracts

Nikolaj Niebuhr Lambertsen and Morten Lund Poulsen

Economics Letters, 2024, vol. 241, issue C

Abstract: Introducing heterogeneous beliefs into a contracting framework allows for considering ethical behavior. Optimal contracts with heterogeneous beliefs need to balance the standard effects of risk aversion and incentives for effort with the desire for exploitation. We study the situation where the principal additionally takes an explicit ethical stance: The agent must not be worse off from accepting the contract than the agent’s outside option according to the principal’s beliefs. In this framework, heterogeneous beliefs still matter, and we fully characterize the optimal contract with an overconfident agent. The agent is strictly better off with an ethical principal. The ethical principal may be better off with an overconfident agent, leading to Pareto improvements in welfare.

Keywords: Ethics; Ethical principals; Heterogeneous beliefs; Moral hazard; Overconfidence (search for similar items in EconPapers)
JEL-codes: D86 D90 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecolet:v:241:y:2024:i:c:s0165176524003252

DOI: 10.1016/j.econlet.2024.111841

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