‘Incentive conscious’ agents and moral hazard

Oindrila Dey and Swapnendu Banerjee (Bandyopadhyay)

Indian Economic Review, 2019, vol. 54, issue 1, No 7, 149-169

Abstract: Abstract This paper characterizes the structure of monetary incentives with varying agent incentive-consciousness. Incentive consciousness arises when the valuation of incentive among agents differs with situations. Using a moral hazard framework with limited liability we show that for agents with low outside option optimal incentive pay is independent of incentive-consciousness whereas for agents with high outside option increased incentive-consciousness leads to increased incentive payment. For agents with very high incentive-consciousness such that the limited liability does not bind, an exogenous increase in incentive-consciousness leads to an unambiguous decrease in optimal incentive payment. Thus, the paper provides a non-monotonic relation between incentive consciousness and optimal incentive pay. With incentive-consciousness, inefficiency in the effort will exist with risk-neutral principal and agent even in the absence of limited liability. This runs contrary to standard incentive theory.

Keywords: Incentive-consciousness; Incentives; Moral hazard; Optimal contract; D86; L20 (search for similar items in EconPapers)
Date: 2019
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DOI: 10.1007/s41775-019-00046-5

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