Insurance versus Incentives

Coen Teulings and Martijn Huysmans ()
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Coen Teulings: Utrecht University
Martijn Huysmans: Utrecht University

Chapter 6 in The Microeconomics of Market Failures and Institutions, 2025, pp 157-180 from Springer

Abstract: Abstract The rise of capitalism has been strongly stimulated by development of institutions for risk diversification, starting from the founding of the Dutch East India Company (VOC) in seventeenth century. Diversification adds value, but is always plagued by a trade-off between insurance and incentives as agents possess asymmetric information not available to principals. The basic principal-agent model shows how insurance and risk-diversification reduce agents’ incentives for effort. The “factory hall” argument highlights how output specificity enables insurance by safeguarding principals’ claim on output. Complications such as multiple layers of hierarchy and multiple principals lead to over-insurance, further weakening agents’ incentives. This is a particular challenge for joint-stock companies with dispersed shareholders. The 2008 financial crisis shows the perils of over-insurance.

Date: 2025
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DOI: 10.1007/978-3-031-74987-2_6

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