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‘Incentive conscious’ agents and moral hazard

Author

Listed:
  • Oindrila Dey

    (FLAME University)

  • Swapnendu Banerjee

    (Jadavpur University)

Abstract

This paper characterizes the structure of monetary incentives with varying agent incentive-consciousness. Incentive consciousness arises when the valuation of incentive among agents differs with situations. Using a moral hazard framework with limited liability we show that for agents with low outside option optimal incentive pay is independent of incentive-consciousness whereas for agents with high outside option increased incentive-consciousness leads to increased incentive payment. For agents with very high incentive-consciousness such that the limited liability does not bind, an exogenous increase in incentive-consciousness leads to an unambiguous decrease in optimal incentive payment. Thus, the paper provides a non-monotonic relation between incentive consciousness and optimal incentive pay. With incentive-consciousness, inefficiency in the effort will exist with risk-neutral principal and agent even in the absence of limited liability. This runs contrary to standard incentive theory.

Suggested Citation

  • Oindrila Dey & Swapnendu Banerjee, 2019. "‘Incentive conscious’ agents and moral hazard," Indian Economic Review, Springer, vol. 54(1), pages 149-169, June.
  • Handle: RePEc:spr:inecre:v:54:y:2019:i:1:d:10.1007_s41775-019-00046-5
    DOI: 10.1007/s41775-019-00046-5
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    References listed on IDEAS

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