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Moral Hazard Severity and Contract Design

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  • Ronald A. Dye

    ()
    (Northwestern University)

  • Sri S. Sridhar

    ()
    (Northwestern University)

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    Abstract

    In an agency setting where the agent must be compensated both to exert effort to produce a new project and to announce honestly when the new project has been produced, we show that Holmstrom's (1979) well-known "informativeness criterion" does not, by itself, determine whether a variable is optimally incorporated into the agent's contract. What also matters is how "severe" the control problem is between the principal and the agent. We further show that the severity of the moral hazard problem also determines whether it is desirable for the principal to have the agent implement the project more often that warranted by first-best implementation considerations.

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    Bibliographic Info

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

    Volume (Year): 36 (2005)
    Issue (Month): 1 (Spring)
    Pages: 78-92

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    Handle: RePEc:rje:randje:v:36:y:2005:1:p:78-92

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    Related research

    Keywords: Asymmetric and Private Information Economics of Contract: Theory Agency; Contracts; Hazard; Moral Hazard;

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