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Moral Hazard and Clear Conscience

  • Topi Miettinen

    ()

    (Max Planck Institute of Economics Jena, Strategic Interaction Group)

We consider guilt averse agents and principals and study the effects of guilt on optimal behavior of the principal and the agent in a moral hazard model. The principal’s contract proposal contains a target effort in addition to the monetary incentive scheme. By accepting the agreement, the parties agree on both the wage scheme and the target. The agent suffers from guilt when failing to provide the target effort, the principal when paying less than the contract requires or when setting an unreasonably high target effort. In equilibrium, a guilt-prone agent chooses a higher effort than an agent who only cares about monetary incentives. The target effort level is always set above the equilibrium effort. Both the agent and the principal gain from the agent’s guilt aversion. A principal who lacks power to commit to the proposed incentive scheme benefits from having a positive proneness to guilt. However, a guilt-prone principal who suffers when setting an unreasonable target is worse off than one with merely monetary motivations.

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Paper provided by Friedrich-Schiller-University Jena, Max-Planck-Institute of Economics in its series Jena Economic Research Papers with number 2007-008.

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Date of creation: 20 Apr 2007
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Handle: RePEc:jrp:jrpwrp:2007-008
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