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Contract Bargaining with a Risk-Averse Agent

  • Li Sanxi

    ()

  • Yao Dongmin

    ()

    (School of Economics, Renmin University of China, Mingde Main Building, Beijing, China)

  • Xiao Hao

    ()

    (School of Economics and Trade, Hunan University, Academy of Mathematics and Systems Science, China Academy of Sciences, Beijing, China)

Registered author(s):

    This article is the first to study a bargaining model in a moral hazard framework where the principal is risk neutral and the agent is risk averse. We show that the power of incentives increases with the agent’s bargaining power if the contracts induce a high effort. However, under reasonable assumptions about the agent’s utility function, the contracts induce a high effort less often as the agent’s bargaining power increases. As for the social welfare, we are surprised to find that a utilitarian, who cares about the sum of the two parties’ certainty equivalents, is worse off as the agent’s bargaining power increases. These results are in sharp contrast to the literature, which features risk-neutral agents protected by limited liability.

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    Article provided by De Gruyter in its journal The B.E. Journal of Theoretical Economics.

    Volume (Year): 13 (2013)
    Issue (Month): 1 (November)
    Pages: 285-301

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    Handle: RePEc:bpj:bejtec:v:13:y:2013:i:1:p:285-301:n:16
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    1. Melissa A. Thomasson, 2000. "The Importance of Group Coverage: How Tax Policy Shaped U.S. Health Insurance," NBER Working Papers 7543, National Bureau of Economic Research, Inc.
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