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Optimal contracts with a risk-taking agent

Author

Listed:
  • Barron, Daniel

    (Kellogg School of Management, Northwestern University)

  • Georgiadis, George

    (Kellogg School of Management, Northwestern University)

  • Swinkels, Jeroen M.

    (Kellogg School of Management, Northwestern University)

Abstract

Consider an agent who can costlessly add mean-preserving noise to his output. To deter such risk-taking, the principal optimally offers a contract that makes the agent's utility concave in output. If the agent is risk-neutral and protected by limited liability, this concavity constraint binds and so linear contracts maximize profit. If the agent is risk averse, the concavity constraint might bind for some outputs but not others. We characterize the unique profit-maximizing contract and show how deterring risk-taking affects the insurance-incentive tradeoff. Our logic extends to costly risk-taking and to dynamic settings where the agent can shift output over time.

Suggested Citation

  • Barron, Daniel & Georgiadis, George & Swinkels, Jeroen M., 2020. "Optimal contracts with a risk-taking agent," Theoretical Economics, Econometric Society, vol. 15(2), May.
    • Handle: RePEc:the:publsh:3660
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    References listed on IDEAS

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    More about this item

    Keywords

    Risk-taking; contract theory; gaming;
    All these keywords.

    JEL classification:

    • M2 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Economics
    • M5 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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