Moral Hazard and Other‐Regarding Preferences
The Japanese Economic Review, 2004, vol. 55, issue 1, 18-45
The paper aims at obtaining new theoretical insights by combining the standard moral hazard models of principal–agent relationships with theories of other‐regarding preferences, in particular inequity aversion theory. The principal is in general worse off, as the agent cares more about the wellbeing of the principal. When there are multiple symmetric agents who care about each other's wellbeing, the principal can optimally exploit their other‐regarding nature by designing an appropriate interdependent contract such as a “fair” team contract or a relative performance contract. The approach taken in this paper can shed light on issues on endogenous preferences within organizations.
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