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Risk aversion, moral hazard, and the principal's loss

Author

Listed:
  • Hector Chade

    (Department of Economics, Arizona State University, Main Campus PO Box 873806, Tempe, AZ 85287-3806, USA)

  • Virginia N. Vera de Serio

    (Facultad de Ciencias Económicas, Universidad Nacional de Cuyo, 5500 Mendoza, ARGENTINA)

Abstract

In their seminal paper on the principal-agent model with moral hazard, Grossman and Hart (1983) show that if the agent's utility function is $U(I,a)=-e^{-k(I-a)}$, then the loss to the principal from being unable to observe the agent's action is increasing in the agent's degree of absolute risk aversion. Their proof is restricted to the case where the number of observable outcomes is equal to two, and it uses an argument that is specific to that case. In this note, we provide an alternative proof that generalizes their result to any (finite) number of outcomes.

Suggested Citation

  • Hector Chade & Virginia N. Vera de Serio, 2002. "Risk aversion, moral hazard, and the principal's loss," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 20(3), pages 637-644.
    • Handle: RePEc:spr:joecth:v:20:y:2002:i:3:p:637-644
    Note: Received: March 21, 2001; revised version: June 21, 2001
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    References listed on IDEAS

    as
    1. Paul Milgrom, "undated". "The Envelope Theorems," Working Papers 99016, Stanford University, Department of Economics.
    2. Grossman, Sanford J & Hart, Oliver D, 1983. "An Analysis of the Principal-Agent Problem," Econometrica, Econometric Society, vol. 51(1), pages 7-45, January.
    3. Haubrich, Joseph G, 1994. "Risk Aversion, Performance Pay, and the Principal-Agent Problem," Journal of Political Economy, University of Chicago Press, vol. 102(2), pages 258-276, April.
    Full references (including those not matched with items on IDEAS)

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    Cited by:

    1. Matthias Lang, 2023. "Stochastic contracts and subjective evaluations," RAND Journal of Economics, RAND Corporation, vol. 54(1), pages 104-134, March.
    2. Daniel McFadden & Carlos Noton & Pau Olivella, "undated". "Remedies for Sick Insurance," Working Papers 620, Barcelona School of Economics.
    3. Flavia Mengarelli & Laura Moretti & Valeria Faralla & Philippe Vindras & Angela Sirigu, 2014. "Economic Decisions for Others: An Exception to Loss Aversion Law," PLOS ONE, Public Library of Science, vol. 9(1), pages 1-6, January.
    4. Jung, Jin Yong, 2022. "Effects of changes in preferences in moral hazard problems," Journal of Economic Theory, Elsevier, vol. 205(C).

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    More about this item

    Keywords

    Moral hazard; Principal-agent; Risk aversion.;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design

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