 Dynamic incentive contracts with controllable riskYuqian Zhang and Zhaojun Yang Journal of Economic Dynamics and Control, 2025, vol. 178, issue C Abstract: We address a dynamic contracting model in which a principal hires an agent to manage a project. The key new ingredient is that either the principal or the agent can dynamically control the project risk. Increasing the risk has three effects: (i) a positive drift effect due to the risk premium, (ii) a negative drift effect that captures inefficiencies arising from risk-shifting, and (iii) a mechanical mean-preserving spread effect. We show that if the principal instead of agent controls the risk, we get a higher contract efficiency. The higher the agent's promised value, the more pronounced the advantage. The non-contractibility of risk induces the agent's risk-taking behavior. The contract efficiency in the exogenous no-savings environment is higher than that in the endogenous one due to additional costs of no-savings incentives. These findings contribute to the allocation of control rights, bringing forth a corporate governance perspective. Keywords: Financial contracting theory; Moral hazard; Controllable risk; Risk-shifting; Contract efficiency (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:178:y:2025:i:c:s0165188925001265 DOI: 10.1016/j.jedc.2025.105160 Access Statistics for this article Journal of Economic Dynamics and Control is currently edited by J. Bullard, C. Chiarella, H. Dawid, C. H. Hommes, P. Klein and C. Otrok More articles in Journal of Economic Dynamics and Control from Elsevier |
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