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A moral solution to the moral hazard problem

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  • Stevens, Douglas E.
  • Thevaranjan, Alex
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    Abstract

    In agency theory, offering a flat salary contract under unobservable effort creates a moral hazard problem because the agent is motivated to shirk and provide less than a previously agreed-upon level of effort. We examine a moral solution to this moral hazard problem. In particular, we present a principal-agent model where the agent possesses some level of moral sensitivity that causes him disutility if he provides less than the agreed-upon level of effort. We examine the interplay between moral sensitivity and firm productivity in determining the optimal salary contract, and contrast our moral solution with the traditional incentive solution that becomes necessary when moral sensitivity is assumed to be zero. This allows us to highlight the benefits of the agent's moral sensitivity to both the principal and the agent, and thereby, point out the potential cost of ignoring this moral sensitivity. We conclude that adding moral sensitivity increases the descriptive, prescriptive, and pedagogical usefulness of the principal-agent model.

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    Bibliographic Info

    Article provided by Elsevier in its journal Accounting, Organizations and Society.

    Volume (Year): 35 (2010)
    Issue (Month): 1 (January)
    Pages: 125-139

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    Handle: RePEc:eee:aosoci:v:35:y:2010:i:1:p:125-139

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    Cited by:
    1. Jan Tichem, 2013. "Endogenous Effort Norms in Hierarchical Firms," Tinbergen Institute Discussion Papers, Tinbergen Institute 13-198/VII, Tinbergen Institute.
    2. Arce, Daniel G., 2013. "Principals’ preferences for agents with social preferences," Journal of Economic Behavior & Organization, Elsevier, Elsevier, vol. 90(C), pages 154-163.
    3. Murphy, Tim & O’Connell, Vincent & Ó hÓgartaigh, Ciarán, 2013. "Discourses surrounding the evolution of the IASB/FASB Conceptual Framework: What they reveal about the “living law” of accounting," Accounting, Organizations and Society, Elsevier, Elsevier, vol. 38(1), pages 72-91.

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