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Hunting with two bullets: moral hazard with a second chance

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  • Paulo Fagandini

Abstract

I study the moral hazard problem where an agent can create an extra instance of effort and potentially improve bad realizations of the outcome before the principal observes it. The agent cannot hide the outcome of his effort, but just the way he achieved it. Findings are that both, principal and agent, value the option of improving the outcome in case of a bad realization if doing so is cheap. I also find that contracted effort is not always decreasing in its cost. I also study the situation in which, if the principal can impose short deadlines and eliminate the agent's extra chance, under a broad range of scenarios, the principal will do so when the parameters make agency costs sufficiently high. Finally, if the creation of the extra instance can cause a punishment for the principal, and if that punishment is sufficiently big, the principal will avoid writing contracts that incentive effort only on the extra chance. JEL codes: D82, D86

Suggested Citation

  • Paulo Fagandini, 2018. "Hunting with two bullets: moral hazard with a second chance," FEUNL Working Paper Series wp629, Universidade Nova de Lisboa, Faculdade de Economia.
  • Handle: RePEc:unl:unlfep:wp629
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    File URL: http://fesrvsd.fe.unl.pt/WPFEUNL/WP2018/Wp629.pdf
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    References listed on IDEAS

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    3. Andrew Clausen, 2013. "Moral Hazard with Counterfeit Signals," ESE Discussion Papers 225, Edinburgh School of Economics, University of Edinburgh.
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    5. Bernard SalaniƩ, 2005. "The Economics of Contracts: A Primer, 2nd Edition," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262195259.
    6. Ernst-Ludwig Thadden & Xiaojian Zhao, 2014. "Multi-task agency with unawareness," Theory and Decision, Springer, vol. 77(2), pages 197-222, August.
    7. Auster, Sarah, 2013. "Asymmetric awareness and moral hazard," Games and Economic Behavior, Elsevier, vol. 82(C), pages 503-521.
    8. Richard H. Thaler & Eric J. Johnson, 1990. "Gambling with the House Money and Trying to Break Even: The Effects of Prior Outcomes on Risky Choice," Management Science, INFORMS, vol. 36(6), pages 643-660, June.
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    10. Maggi G. & Rodriguez-Clare A., 1995. "On Countervailing Incentives," Journal of Economic Theory, Elsevier, vol. 66(1), pages 238-263, June.
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    More about this item

    Keywords

    moral hazard; asymmetric information; contract theory; second chance;

    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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