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Non-monotone Incentives in a Model of Coexisting Hidden Action and Hidden Information

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  • Suren Basov

Abstract

In this paper I consider a model of coexisting moral hazard and adverse selection, similar to one considered by Guesnerie, Picard, and Rey (1989). I provide an explicit solution for the optimal incentive scheme in the case, when the effort is observed with a normally distributed error. The main observation is that in this case the optimal incentive scheme often fails to be monotone. If the monotonicity constraint is imposed on the solution for economic reasons there would exist a region of profit realizations, such that the optimal compensation will be independent of on performance.

Suggested Citation

  • Suren Basov, 2006. "Non-monotone Incentives in a Model of Coexisting Hidden Action and Hidden Information," Department of Economics - Working Papers Series 979, The University of Melbourne.
    • Handle: RePEc:mlb:wpaper:979
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    File URL: http://www.economics.unimelb.edu.au/downloads/wpapers-06/979.pdf
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    References listed on IDEAS

    as
    1. Melumad, Nahum D. & Reichelstein, Stefan, 1989. "Value of communication in agencies," Journal of Economic Theory, Elsevier, vol. 47(2), pages 334-368, April.
    2. Suren Basov & Peter Bardsley, 2005. "A General Model of Coexisting Hidden Action and Hidden Information," Department of Economics - Working Papers Series 958, The University of Melbourne.
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    JEL classification:

    • C6 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling
    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty

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