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The Moral Hazard of Budget-Breaking

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  • Mukesh Eswaran
  • Ashok Kotwal

Abstract

It has recently been suggested in the agency literature that moral hazard in teams can be dealt with by introducing a third party who breaks the budget-balancing constraint, and that this facilitates the design of contracts that can sustain the Pareto optimum as a (perfect) Nash equilibrium. This note offers an explanation for why the use of budget-breaking schemes is not so widespread as that of active monitoring, despite the fact that such schemes would save the resources expended on supervision. The note demonstrates that allowing the budget to be broken introduces the potential for moral hazard on the part of the third party, which could render the proposed equilibrium incredible.

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Bibliographic Info

Article provided by The RAND Corporation in its journal RAND Journal of Economics.

Volume (Year): 15 (1984)
Issue (Month): 4 (Winter)
Pages: 578-581

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Handle: RePEc:rje:randje:v:15:y:1984:i:winter:p:578-581

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Cited by:
  1. Charness, Gary & Kuhn, Peter, 2011. "Lab Labor: What Can Labor Economists Learn from the Lab?," Handbook of Labor Economics, Elsevier.
  2. Keuschnigg, Christian & Ribi, Evelyn, 2009. "Profit Taxation and Finance Constraints," CEPR Discussion Papers 7433, C.E.P.R. Discussion Papers.
  3. Avner Ben-Ner & Matthew Ellman, 2013. "The contributions of behavioural economics to understanding and advancing the sustainability of worker cooperatives," Journal of Entrepreneurial and Organizational Diversity, European Research Institute on Cooperative and Social Enterprises, vol. 2(1), pages 75-100, August.
  4. Nikolowa, Radoslawa, 2014. "Developing new ideas: Spin-outs, spinoffs, or internal divisions," Journal of Economic Behavior & Organization, Elsevier, vol. 98(C), pages 70-88.
  5. Matthew Ellman, 2004. "Specificity revisited: The role of cross-investments," Economics Working Papers 799, Department of Economics and Business, Universitat Pompeu Fabra, revised Jan 2005.
  6. Kirstein, Roland & Cooter, Robert D, 2006. "Anti-Sharing as a Theory of Partnerships and Firms," Berkeley Olin Program in Law & Economics, Working Paper Series qt4441r9r1, Berkeley Olin Program in Law & Economics.
  7. Useche, Pilar & Blare, Trent, 2013. "Traditional vs. modern production systems: Price and nonmarket considerations of cacao producers in Northern Ecuador," Ecological Economics, Elsevier, vol. 93(C), pages 1-10.
  8. Sandeep Baliga & Tomas Sjostrom, 2005. "Contracting with Third Parties," Levine's Bibliography 784828000000000408, UCLA Department of Economics.
  9. Martin Gaynor, 1989. "The presence of moral hazard in budget breaking," Public Choice, Springer, vol. 61(3), pages 261-267, June.
  10. Christian Keuschnigg & Evelyn Ribi, 2013. "Profit taxes and financing constraints," International Tax and Public Finance, Springer, vol. 20(5), pages 808-826, October.
  11. repec:hal:journl:halshs-00151509 is not listed on IDEAS

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