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Simple contracts with adverse selection and moral hazard

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  • Gottlieb, Daniel
  • Moreira, Humberto

Abstract

We study a principal-agent model with moral hazard and adverse selection. Risk-neutral agents with limited liability have arbitrary private information about the distribution of outputs and the cost of effort. We show that under a multiplicative separability condition, the optimal mechanism offers a single contract. This condition holds, for example, when output is binary. If the principal’s payoff must also satisfy free disposal and the distribution of outputs has the monotone likelihood ratio property, the mechanism offers a single debt contract. Our results generalize if the output distribution is “close” to multiplicatively separable. Our model suggests that offering a single contract may be optimal in environments with adverse selection and moral hazard when agents are risk neutral and have limited liability.

Suggested Citation

  • Gottlieb, Daniel & Moreira, Humberto, 2022. "Simple contracts with adverse selection and moral hazard," LSE Research Online Documents on Economics 114348, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:114348
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    File URL: http://eprints.lse.ac.uk/114348/
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    2. Tal Alon & Paul Dutting & Yingkai Li & Inbal Talgam-Cohen, 2022. "Bayesian Analysis of Linear Contracts," Papers 2211.06850, arXiv.org, revised Jul 2023.

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    More about this item

    Keywords

    principal-agent problem; contract theory; mechanism design;
    All these keywords.

    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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