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Optimal Incentive Contracts under Moral Hazard When the Agent is Free to Leave

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  • Englmaier, Florian
  • Muehlheusser, Gerd
  • Roider, Andreas

Abstract

We characterize optimal incentive contracts in a moral hazard framework extended in two directions. First, after effort provision, the agent is free to leave and pursue some ex-post outside option. Second, the value of this outside option is increasing in effort, and hence endogenous. Optimal contracts may entail properties such as inducing first-best effort and surplus, or non-responsiveness with respect to changes in verifiable parameters. Moreover, while always socially inefficient, separation might occur in equilibrium. Except for the latter, these findings are robust to renegotiation. When the outside option is exogenous instead, the standard results obtain.

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Paper provided by Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich in its series Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems with number 329.

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Date of creation: Jul 2010
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Handle: RePEc:trf:wpaper:329

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Keywords: moral hazard; limited commitment; ex-post outside option; limited liability;

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  1. O'Flaherty, B. & Siow, A., 1990. "Up or Out Rules in the Market for Lawers," University of Chicago - Economics Research Center 90-10, Chicago - Economics Research Center.
  2. Rasul, Imran & Sonderegger, Silvia, 2010. "The role of the agent's outside options in principal-agent relationships," Games and Economic Behavior, Elsevier, vol. 68(2), pages 781-788, March.
  3. Nick Netzer & Florian Scheuer, 2008. "Competitive Markets without Commitment," SOI - Working Papers 0814, Socioeconomic Institute - University of Zurich.
  4. Hvide, Hans K & Kristiansen, Eirik Gaard, 2007. "Management of Knowledge Workers," CEPR Discussion Papers 6039, C.E.P.R. Discussion Papers.
  5. Anton, James J & Yao, Dennis A, 1995. "Start-ups, Spin-offs, and Internal Projects," Journal of Law, Economics and Organization, Oxford University Press, vol. 11(2), pages 362-78, October.
  6. Kräkel, Matthias & Sliwka, Dirk, 2006. "Should You Allow Your Agent to Become Your Competitor? On Non-Compete Agreements in Employment Contracts," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 99, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
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