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Contract Bargaining with a Risk-Averse Agent

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  • Li Sanxi

    ()

  • Yao Dongmin

    ()
    (School of Economics, Renmin University of China, Mingde Main Building, Beijing, China)

  • Xiao Hao

    ()
    (School of Economics and Trade, Hunan University, Academy of Mathematics and Systems Science, China Academy of Sciences, Beijing, China)

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    Abstract

    This article is the first to study a bargaining model in a moral hazard framework where the principal is risk neutral and the agent is risk averse. We show that the power of incentives increases with the agent’s bargaining power if the contracts induce a high effort. However, under reasonable assumptions about the agent’s utility function, the contracts induce a high effort less often as the agent’s bargaining power increases. As for the social welfare, we are surprised to find that a utilitarian, who cares about the sum of the two parties’ certainty equivalents, is worse off as the agent’s bargaining power increases. These results are in sharp contrast to the literature, which features risk-neutral agents protected by limited liability.

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    Bibliographic Info

    Article provided by De Gruyter in its journal The B.E. Journal of Theoretical Economics.

    Volume (Year): 13 (2013)
    Issue (Month): 1 (November)
    Pages: 285-301

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    Handle: RePEc:bpj:bejtec:v:13:y:2013:i:1:p:285-301:n:16

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    1. Brent Hueth & Ethan Ligon, 1999. "Producer Price Risk and Quality Measurement," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 81(3), pages 512-524.
    2. Viaene, Stijn & Veugelers, Reinhilde & Dedene, Guido, 2002. "Insurance bargaining under risk aversion," Economic Modelling, Elsevier, vol. 19(2), pages 245-259, March.
    3. S. Andrew Starbird, 2005. "Moral Hazard, Inspection Policy, and Food Safety," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 87(1), pages 15-27.
    4. Demougin, Dominique & Helm, Carsten, 2011. "Job matching when employment contracts suffer from moral hazard," European Economic Review, Elsevier, vol. 55(7), pages 964-979.
    5. Melissa A. Thomasson, 2000. "The Importance of Group Coverage: How Tax Policy Shaped U.S. Health Insurance," NBER Working Papers 7543, National Bureau of Economic Research, Inc.
    6. Genicot, Garance & Ray, Debraj, 2006. "Bargaining power and enforcement in credit markets," Journal of Development Economics, Elsevier, vol. 79(2), pages 398-412, April.
    7. Pierre Dubois & Tomislav Vukina, 2004. "Grower Risk Aversion and the Cost of Moral Hazard in Livestock Production Contracts," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 86(3), pages 835-841.
    8. Dieter Balkenborg, 2001. "How Liable Should a Lender Be? The Case of Judgment-Proof Firms and Environmental Risk: Comment," American Economic Review, American Economic Association, vol. 91(3), pages 731-738, June.
    9. Schmitz, Patrick W., 2005. "Workplace surveillance, privacy protection, and efficiency wages," Labour Economics, Elsevier, vol. 12(6), pages 727-738, December.
    10. Yao, Zhiyong, 2012. "Bargaining over incentive contracts," Journal of Mathematical Economics, Elsevier, vol. 48(2), pages 98-106.
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