Contract Bargaining with a Risk-Averse Agent

Li Sanxi (), Xiao Hao () and Yao Dongmin ()
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Li Sanxi: School of Economics, Renmin University of China, Mingde Main Building, Beijing, China
Xiao Hao: School of Economics and Trade, Hunan University, Academy of Mathematics and Systems Science, China Academy of Sciences, Beijing, China
Yao Dongmin: School of Economics, Renmin University of China, Mingde Main Building, Beijing, China

The B.E. Journal of Theoretical Economics, 2013, vol. 13, issue 1, 285-301

Abstract: This article is the first to study a bargaining model in a moral hazard framework where the principal is risk neutral and the agent is risk averse. We show that the power of incentives increases with the agent’s bargaining power if the contracts induce a high effort. However, under reasonable assumptions about the agent’s utility function, the contracts induce a high effort less often as the agent’s bargaining power increases. As for the social welfare, we are surprised to find that a utilitarian, who cares about the sum of the two parties’ certainty equivalents, is worse off as the agent’s bargaining power increases. These results are in sharp contrast to the literature, which features risk-neutral agents protected by limited liability.

Keywords: moral hazard; risk averse agent; bargaining (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (2)

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DOI: 10.1515/bejte-2013-0041

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