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Non-monotone Incentives in a Model of Coexisting Hidden Action and Hidden Information

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  • Suren Basov

Abstract

In this paper I consider a model of coexisting moral hazard and adverse selection, similar to one considered by Guesnerie, Picard, and Rey (1989). I provide an explicit solution for the optimal incentive scheme in the case, when the effort is observed with a normally distributed error. The main observation is that in this case the optimal incentive scheme often fails to be monotone. If the monotonicity constraint is imposed on the solution for economic reasons there would exist a region of profit realizations, such that the optimal compensation will be independent of on performance.

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Bibliographic Info

Paper provided by The University of Melbourne in its series Department of Economics - Working Papers Series with number 979.

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Length: 16 pages
Date of creation: 2006
Date of revision:
Handle: RePEc:mlb:wpaper:979

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Keywords: hidden action; hidden information; Fredholmintegral equations of the first type; Hermit polynomials.;

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  1. Suren Basov & Peter Bardsley, 2005. "A General Model of Coexisting Hidden Action and Hidden Information," Department of Economics - Working Papers Series 958, The University of Melbourne.
  2. Picard, Pierre, 1987. "On the design of incentive schemes under moral hazard and adverse selection," Journal of Public Economics, Elsevier, vol. 33(3), pages 305-331, August.
  3. Melumad, Nahum D. & Reichelstein, Stefan, 1989. "Value of communication in agencies," Journal of Economic Theory, Elsevier, vol. 47(2), pages 334-368, April.
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