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On the Optimality of One-size-fits-all Contracts: The Limited Liability Case

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  • Felipe Balmaceda

Abstract

In this paper I study a multi-task principal agent model with a risk-neutral principal and a risk neutral agent subject to limited liability in an environment with adverse selection and moral hazard. The main results are as follows: (1) the optimal contracts in each possible case is a bonus-type contract that pays a bonus only when the highest signal is realized; (2) the informational rent as well as the limited liability rent are not independent; and (3) under moral and adverse selection the bonus contract exhibits a one-size-fits-all property; that is, in equilibrium all agents are offered the same contract. Under this contract more talented agents work harder and have a higher expected payoff and are on average more productive than less talented agents. This provides a rationale for the absence of menu of contracts in many different settings such as sales contracts, debt contracts, farming workers and optimal regulation. JEL-Classification: D82, D86, J33. Key words: Moral Hazard, Adverse Selection, Multiple Tasks, Limited Liability.

Suggested Citation

  • Felipe Balmaceda, 2012. "On the Optimality of One-size-fits-all Contracts: The Limited Liability Case," Documentos de Trabajo 291, Centro de Economía Aplicada, Universidad de Chile.
    • Handle: RePEc:edj:ceauch:291
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    Cited by:

    1. Felipe Balmaceda, 2020. "Contracting with moral hazard, adverse selection and risk neutrality: when does one size fit all?," International Journal of Game Theory, Springer;Game Theory Society, vol. 49(2), pages 601-637, June.
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    3. Escobar, Juan F. & Pulgar, Carlos, 2017. "Motivating with simple contracts," International Journal of Industrial Organization, Elsevier, vol. 54(C), pages 192-214.

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    More about this item

    Keywords

    moral hazard; adverse selection; multiple tasks; limited liability.;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods

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