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Standards and Incentives under Moral Hazard with Limited Liability

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  • Reinshagen, Felix

Abstract

We consider a model of moral hazard with limited liability of the agent and effort that is two-dimensional. One dimension of the agent’s effort is observable and the other is not. The principal can thusmake the contract conditional not only on outcome but also on observable effort. The principal’s optimal contract gives the agent no rent and – in contrast to the first-best allocation – uses toomuch observable effort and too little unobservable effort. This distortion in the relative use of the two kinds of effort increases if the agent’s liability becomes more limited.

Suggested Citation

  • Reinshagen, Felix, 2012. "Standards and Incentives under Moral Hazard with Limited Liability," Discussion Papers in Economics 12750, University of Munich, Department of Economics.
    • Handle: RePEc:lmu:muenec:12750
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    References listed on IDEAS

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    5. Bhole, Bharat & Wagner, Jeffrey, 2008. "The joint use of regulation and strict liability with multidimensional care and uncertain conviction," International Review of Law and Economics, Elsevier, vol. 28(2), pages 123-132, June.
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    More about this item

    Keywords

    moral hazard; two-dimensional effort; regulation;
    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
    • K32 - Law and Economics - - Other Substantive Areas of Law - - - Energy, Environmental, Health, and Safety Law

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