Moral Hazard From Costless Hidden Actions

Martin Byford

Working Papers from School of Economics, La Trobe University

Abstract: Principal-agent models typically rely on the assumption that the agents action has a positive and increasing marginal cost in order to explain the emergence of a moral hazard. This paper develops a model in which an agent can manipulate a projects type, and in particular the projects risk, through a costless hidden action. It is shown that even though the action is costless, the agents career concerns may give rise to preferences over the type space that deviate from those of the principal. With the agents action hidden, these preferences create a moral hazard.

Pages: 33 pages
Date: 2003
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