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Moral Hazard Severity and Contract Design


  • Ronald A. Dye

    () (Northwestern University)

  • Sri S. Sridhar

    () (Northwestern University)


In an agency setting where the agent must be compensated both to exert effort to produce a new project and to announce honestly when the new project has been produced, we show that Holmstrom's (1979) well-known "informativeness criterion" does not, by itself, determine whether a variable is optimally incorporated into the agent's contract. What also matters is how "severe" the control problem is between the principal and the agent. We further show that the severity of the moral hazard problem also determines whether it is desirable for the principal to have the agent implement the project more often that warranted by first-best implementation considerations.

Suggested Citation

  • Ronald A. Dye & Sri S. Sridhar, 2005. "Moral Hazard Severity and Contract Design," RAND Journal of Economics, The RAND Corporation, vol. 36(1), pages 78-92, Spring.
  • Handle: RePEc:rje:randje:v:36:y:2005:1:p:78-92

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    Cited by:

    1. Richard Saouma, 2008. "Optimal Second-Stage Outsourcing," Management Science, INFORMS, vol. 54(6), pages 1147-1159, June.
    2. Hensher, David A. & Ho, Chinh & Knowles, Louise, 2016. "Efficient contracting and incentive agreements between regulators and bus operators: The influence of risk preferences of contracting agents on contract choice," Transportation Research Part A: Policy and Practice, Elsevier, vol. 87(C), pages 22-40.

    More about this item


    Asymmetric and Private Information Economics of Contract: Theory Agency; Contracts; Hazard; Moral Hazard;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law


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