Risk Taking Under Limited Liability and Moral Hazard: Quantifying the Role of Motivated Beliefs

Ciril Bosch-Rosa (), Daniel Gietl () and Frank Heinemann
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Ciril Bosch-Rosa: Chair of Macroeconomics, Technische Universität Berlin, 10623 Berlin, Germany
Daniel Gietl: Bavarian Ministry of Digitization, 80333 Munich, Germany

Management Science, 2025, vol. 71, issue 2, 976-991

Abstract: This paper investigates whether limited liability and moral hazard affect risk taking through motivated beliefs. On the one hand, limited liability encourages investors to take excessive risks. On the other, excessive risk taking makes it hard for investors to maintain a positive self-image when moral hazard is present. Using a novel experimental design, we show that subjects form motivated beliefs to self-justify their excessive risk taking. For the same investment opportunity, subjects invest more and are significantly more optimistic about the success of the investment if its failure can harm others. We show that more than one third of the investment increases under limited liability, and moral hazard can be explained through motivated beliefs. Moreover, through a treatment with limited liability but no moral hazard, we show that motivated beliefs are formed subconsciously and can lead to the paradoxical result of investors taking larger risks when their investment can harm a third party compared with when it cannot. These results underscore the importance of motivated beliefs in regulatory policy, emphasizing that policymakers must not only address bad incentives, but also address the role of bad beliefs.

Keywords: limited liability; motivated beliefs; experiment; moral hazard (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:71:y:2025:i:2:p:976-991

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