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Standards and Incentives under Moral Hazard with Limited Liability

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  • Reinshagen, Felix
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    Abstract

    We consider a model of moral hazard with limited liability of the agent and effort that is two-dimensional. One dimension of the agent’s effort is observable and the other is not. The principal can thusmake the contract conditional not only on outcome but also on observable effort. The principal’s optimal contract gives the agent no rent and – in contrast to the first-best allocation – uses toomuch observable effort and too little unobservable effort. This distortion in the relative use of the two kinds of effort increases if the agent’s liability becomes more limited.

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    File URL: http://epub.ub.uni-muenchen.de/12750/1/Reinshagen-Standards_and_Incentives_under_Moral_Hazard_with_Limited_Liability.pdf
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    Bibliographic Info

    Paper provided by University of Munich, Department of Economics in its series Discussion Papers in Economics with number 12750.

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    Date of creation: Feb 2012
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    Handle: RePEc:lmu:muenec:12750

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    Keywords: moral hazard; two-dimensional effort; regulation;

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    1. Bhole, Bharat & Wagner, Jeffrey, 2008. "The joint use of regulation and strict liability with multidimensional care and uncertain conviction," International Review of Law and Economics, Elsevier, vol. 28(2), pages 123-132, June.
    2. Roland Strausz, . "Buried in Paperwork: Excessive Reporting in Organizations," Papers 021, Departmental Working Papers.
    3. Laux, Christian, 2001. "Limited-Liability and Incentive Contracting with Multiple Projects," RAND Journal of Economics, The RAND Corporation, vol. 32(3), pages 514-26, Autumn.
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