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Flexible moral hazard problems

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  • Georgiadis, George
  • Ravid, Doron
  • Szentes, Balázs

Abstract

This paper considers a moral hazard problem where the agent can choose any output distribution with a support in a given compact set. The agent's effort-cost is smooth and increasing in first-order stochastic dominance. To analyze this model, we develop a generalized notion of the first-order approach applicable to optimization problems over measures. We demonstrate each output distribution can be implemented and identify those contracts that implement that distribution. These contracts are characterized by a simple first-order condition for each output that equates the agent's marginal cost of changing the implemented distribution around that output with its marginal benefit. Furthermore, the agent's wage is shown to be increasing in output. Finally, we consider the problem of a profit-maximizing principal and provide a first-order characterization of principal-optimal distributions.

Suggested Citation

  • Georgiadis, George & Ravid, Doron & Szentes, Balázs, 2024. "Flexible moral hazard problems," LSE Research Online Documents on Economics 122548, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:122548
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    File URL: http://eprints.lse.ac.uk/122548/
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    References listed on IDEAS

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    1. Hong, Chew Soo & Karni, Edi & Safra, Zvi, 1987. "Risk aversion in the theory of expected utility with rank dependent probabilities," Journal of Economic Theory, Elsevier, vol. 42(2), pages 370-381, August.
    2. Innes, Robert D., 1990. "Limited liability and incentive contracting with ex-ante action choices," Journal of Economic Theory, Elsevier, vol. 52(1), pages 45-67, October.
    3. Palomino, Frederic & Prat, Andrea, 2003. "Risk Taking and Optimal Contracts for Money Managers," RAND Journal of Economics, The RAND Corporation, vol. 34(1), pages 113-137, Spring.
    4. Gabriel Carroll, 2019. "Robustness in Mechanism Design and Contracting," Annual Review of Economics, Annual Reviews, vol. 11(1), pages 139-166, August.
    5. Peter Diamond, 1998. "Managerial Incentives: On the Near Linearity of Optimal Compensation," Journal of Political Economy, University of Chicago Press, vol. 106(5), pages 931-957, October.
    6. Holmstrom, Bengt & Milgrom, Paul, 1987. "Aggregation and Linearity in the Provision of Intertemporal Incentives," Econometrica, Econometric Society, vol. 55(2), pages 303-328, March.
    7. Hellwig, Martin F., 2007. "The role of boundary solutions in principal-agent problems of the Holmstrom-Milgrom type," Journal of Economic Theory, Elsevier, vol. 136(1), pages 446-475, September.
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    Cited by:

    1. Paul Duetting & Michal Feldman & Inbal Talgam-Cohen, 2024. "Algorithmic Contract Theory: A Survey," Papers 2412.16384, arXiv.org.
    2. Kailin Chen, 2025. "Experiments in the Linear Convex Order," Papers 2502.06530, arXiv.org, revised Mar 2025.

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    More about this item

    Keywords

    principle-agent; moral hazard; contract theory;
    All these keywords.

    JEL classification:

    • J1 - Labor and Demographic Economics - - Demographic Economics

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