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Overconfidence and moral hazard

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  • de la Rosa, Leonidas Enrique

Abstract

In this paper, I study the effects of overconfidence on incentive contracts in a moral-hazard framework. Agent overconfidence can have conflicting effects on the equilibrium contract. On the one hand, an optimistic or overconfident agent disproportionately values success-contingent payments, and thus prefers higher-powered incentives. On the other hand, if the agent overestimates the extent to which his actions affect outcomes, lower-powered incentives are sufficient to induce any given effort level. If the agent is moderately overconfident, the latter effect dominates. Because the agent bears less risk in this case, there are efficiency gains stemming from his overconfidence. If the agent is significantly overconfident, the former effect dominates; the agent is then exposed to an excessive amount of risk, and any gains arise only from risk-sharing under disagreement. An increase in optimism or overconfidence increases the effort level implemented in equilibrium.

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Bibliographic Info

Article provided by Elsevier in its journal Games and Economic Behavior.

Volume (Year): 73 (2011)
Issue (Month): 2 ()
Pages: 429-451

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Handle: RePEc:eee:gamebe:v:73:y:2011:i:2:p:429-451

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Web page: http://www.elsevier.com/locate/inca/622836

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Keywords: Overconfidence; Heterogeneous beliefs; Moral Hazard;

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Cited by:
  1. Wang, Jian & Sheng, Jiliang & Yang, Jun, 2013. "Optimism bias and incentive contracts in portfolio delegation," Economic Modelling, Elsevier, vol. 33(C), pages 493-499.
  2. Sarah Auster, 2012. "Asymmetric Awareness and Moral Hazard," Economics Working Papers, European University Institute ECO2012/23, European University Institute.
  3. Philipp Meyer-Brauns, 2014. "Optimal Auditing with Heterogeneous Audit Perceptions," Working Papers, Max Planck Institute for Tax Law and Public Finance tax-mpg-rps-2014-06, Max Planck Institute for Tax Law and Public Finance.
  4. Santos-Pinto, Luís, 2003. "Positive self-image and incentives in organizations," MPRA Paper 3141, University Library of Munich, Germany, revised 14 Feb 2007.
  5. Santos-Pinto, Luís, 2003. "Positive self-image in tournaments," MPRA Paper 3140, University Library of Munich, Germany, revised 27 Feb 2007.
  6. Iossa, Elisabetta & Martimort, David, 2013. "Hidden Action or Hidden Information? How Information Gathering Shapes Contract Design," CEPR Discussion Papers, C.E.P.R. Discussion Papers 9552, C.E.P.R. Discussion Papers.
  7. Philipp Weinschenk, 2010. "Moral Hazard and Ambiguity," Working Paper Series of the Max Planck Institute for Research on Collective Goods, Max Planck Institute for Research on Collective Goods 2010_39, Max Planck Institute for Research on Collective Goods.
  8. Sloof, Randolph & van Praag, C. Mirjam, 2010. "The effect of noise in a performance measure on work motivation: A real effort laboratory experiment," Labour Economics, Elsevier, Elsevier, vol. 17(5), pages 751-765, October.
  9. Schrand, Catherine M. & Zechman, Sarah L.C., 2012. "Executive overconfidence and the slippery slope to financial misreporting," Journal of Accounting and Economics, Elsevier, Elsevier, vol. 53(1), pages 311-329.
  10. Auster, Sarah, 2013. "Asymmetric awareness and moral hazard," Games and Economic Behavior, Elsevier, Elsevier, vol. 82(C), pages 503-521.
  11. Herweg, Fabian & Müller, Daniel, 2011. "Overconfidence in the Market for Lemons," Discussion Papers in Economics 12411, University of Munich, Department of Economics.
  12. Ludwig, Sandra & Wichardt, Philip C. & Wickhorst, Hanke, 2011. "On the Positive Effects of Overcon fident Self-Perception in Teams," Discussion Papers in Economics 12246, University of Munich, Department of Economics.
  13. Sarah Auster, 2011. "Asymmetric Awareness and Moral Hazard," Economics Working Papers, European University Institute ECO2011/, European University Institute.
  14. Gyorgy Attila, 2012. "Agency Problems In Public Sector," Annals of Faculty of Economics, University of Oradea, Faculty of Economics, vol. 1(1), pages 708-712, July.
  15. Anja Sautmann, 2013. "Contracts for Agents with Biased Beliefs: Some Theory and an Experiment," American Economic Journal: Microeconomics, American Economic Association, American Economic Association, vol. 5(3), pages 124-56, August.

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