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Double Moral Hazard, Monitoring, and the Nature of Contracts

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  • Pradeep Agrawal

    (RBI Chair Unit, Institute of Economic Growth, University Enclave, Delhi 110 007, India (e-mail: pradeep@ieg.ernet.in.))

Abstract

generalized double-sided moral-hazard model, with risk-averse parties who mutually monitor each other (to get a reasonable idea of outcome/effort). The model considers trade-off between monitoring costs and moral hazard costs, which are endogenously determined by the extent of monitoring. Using this model, we formally prove a generalized version of Coase's conjecture – that the optimal contract minimizes the agency and risk costs. We then show how varying assumptions about the feasibility or cost of monitoring of the outcome or the worker's effort lead to different contracts being optimal. The analysis is then used to explain the nature of contracts observed in practice under many different situations. We will give an explanation as to why industrial workers typically work under wage contracts, while share contracts are common in agriculture and will explain why profit sharing is more common for senior managers than for the production workers.

Suggested Citation

  • Pradeep Agrawal, 2002. "Double Moral Hazard, Monitoring, and the Nature of Contracts," Journal of Economics, Springer, vol. 75(1), pages 33-61, January.
  • Handle: RePEc:kap:jeczfn:v:75:y:2002:i:1:d:10.1007_s007120200002
    DOI: 10.1007/s007120200002
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    Cited by:

    1. Xun Liu & Sen Lin & Lixing Liu & Fei Qian & Kun Zhang, 2020. "Exploring the Factors Triggering Occupational Ethics Risk of Technology Transaction in Chinese Construction Industry," IJERPH, MDPI, vol. 17(4), pages 1-18, February.
    2. Verena Nowak & Christian Schwarz & Jens Suedekum, 2012. "On the Organizational Structure of Multinational Firms - Which Sourcing Mode for which Input?," CESifo Working Paper Series 3823, CESifo.
    3. Dur, Robert & Non, Arjan & Roelfsema, Hein, 2010. "Reciprocity and incentive pay in the workplace," Journal of Economic Psychology, Elsevier, vol. 31(4), pages 676-686, August.
    4. Major, Iván, 2014. "Ha elfogy a bizalom... Kialakítható-e optimális mechanizmus kétoldalú aszimmetrikus információ esetén? [When confidence evaporates&. Does optimal mechanism design exist under doubly asymmetric info," Közgazdasági Szemle (Economic Review - monthly of the Hungarian Academy of Sciences), Közgazdasági Szemle Alapítvány (Economic Review Foundation), vol. 0(2), pages 148-165.
    5. Eleonora Fichera & James Banks & Matt Sutton, 2014. "Health behaviours and the patient-doctor interaction: The double moral hazard problem," Economics Discussion Paper Series 1415, Economics, The University of Manchester.
    6. Hirnle, Christoph & Hess, Thomas, 2005. "Bewertung unternehmensübergreifender IT Investitionen in Unternehmensnetzwerken: Ein Property-Rights basierter Zugang," Working Papers 4/2005, University of Munich, Munich School of Management, Institute for Information Systems and New Media.

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