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The First-Order Approach when the Cost of Effort is Money

Marie-Cecile Fagart and Claude Fluet ()

Cahiers de recherche from CIRPEE

Abstract: We provide sufficient conditions for the first-order approach in the principal-agent problem when the agent’s utility has the non-separable form u(y - c(a)) where y is the contractual payoff and c(a) is the money cost of effort. We first consider a decision-maker facing prospects which cost c(a) with distributions of returns y that depends on a. The decision problem is shown to be concave if the primitive of the cumulative distribution of returns is a convex function, a condition we call Concavity of the Cumulative Quantile (CCQ). Next we apply CCQ to the distribution of outcomes (or their likelihood-ratio transforms) in the principal-agent problem and derive restrictions on the utility function that validate the first-order approach. We also discuss a stronger condition, log-convexity of the distribution, and show that it allows binding limited liability constraints, which CCQ does not.

Keywords: Principal-agent models; moral hazard; stochastic decision problem; quantile function; information systems (search for similar items in EconPapers)
JEL-codes: D81 D82 D86 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cta, nep-mic and nep-ore
Date: 2012
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Journal Article: The first-order approach when the cost of effort is money (2013) Downloads
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