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Optimal Contracts under Moral Hazard and Costly Lying

Keeyoung Rhee
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Keeyoung Rhee: Korea Development Institute

Korean Economic Review, 2021, vol. 37, 115-140

Abstract: We present a model in which the agent reports a privately observed signal about the stochastic outcome of her action, while bearing a cost of misreporting her private information. If the agent receives a low payment contingent on her performance, it is very costly for the agent to misreport her information to the principal so that the principal makes a decision favorable to the agent. However, if the contingent compensation is too high, the principal will terminate the project unless the agent truthfully reports that the project is likely to give a high return. The optimal outcome is achieved by a contract with the fee structure loosely tied with the outcome, but the cost of lying is necessarily high.

Keywords: Contract theory; moral hazard; strategic communication; lying costs (search for similar items in EconPapers)
JEL-codes: D83 D86 (search for similar items in EconPapers)
Date: 2021
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