The moral hazard problem with high stakes

Hector Chade and Jeroen Swinkels

Journal of Economic Theory, 2020, vol. 187, issue C

Abstract: We study the moral-hazard problem when the agent's reservation utility is large, but so is the agent's value to the principal. We show that the principal's cost of implementing effort has a very simple limiting form. For large enough outside option, the principal's cost is convex in the action, so the optimally-implemented action is unique, and optimal effort rises with the agent's ability, and falls with the agent's wealth and outside option. In a competitive market setting where heterogenous principals and agents match, positive sorting ensues and effort increases in match quality, despite conflicting forces.

Keywords: Moral hazard; First-order approach; Principal-agent problem; Comparative statics; Matching (search for similar items in EconPapers)
JEL-codes: D82 D86 (search for similar items in EconPapers)
Date: 2020
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jetheo:v:187:y:2020:i:c:s0022053120300363

DOI: 10.1016/j.jet.2020.105032

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