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The Optimal Contract under Adverse Selection in a Moral-Hazard Model with a Risk-Averse Agent

Author

Listed:
  • François Maréchal

    (CRESE EA3190, University Bourgogne Franche-Comté, F-25000 Besançon, France)

  • Lionel Thomas

    (CRESE EA3190, University Bourgogne Franche-Comté, F-25000 Besançon, France)

Abstract

This paper studies the optimal contract offered by a risk-neutral principal to a risk-averse agent when the agent’s hidden ability and action both improve the probability of the project being successful. We show that if the agent is sufficiently prudent and able, the principal induces a higher probability of success than under moral hazard, despite the costly informational rent given up. Moreover, there is distortion at the top. Finally, the conditions to avoid pooling are difficult to satisfy because of the different kinds of incentives to be managed and the overall trade-off between rent extraction, insurance, and efficiency involved.

Suggested Citation

  • François Maréchal & Lionel Thomas, 2018. "The Optimal Contract under Adverse Selection in a Moral-Hazard Model with a Risk-Averse Agent," Games, MDPI, vol. 9(1), pages 1-22, March.
    • Handle: RePEc:gam:jgames:v:9:y:2018:i:1:p:12-:d:134141
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    References listed on IDEAS

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    Cited by:

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    3. Castro-Pires, Henrique & Moreira, Humberto, 2021. "Limited liability and non-responsiveness in agency models," Games and Economic Behavior, Elsevier, vol. 128(C), pages 73-103.
    4. Roberto Sarkisian, 2021. "Screening Teams of Moral and Altruistic Agents," Games, MDPI, vol. 12(4), pages 1-11, October.

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