Working Paper: CEPR ID: DP3076
Authors: Bruno Jullien; Bernard Salani; François Salani
Abstract: Principal-agent models of moral hazard have been developed under the assumption that the principal knows the agent's risk-aversion. This Paper extends the moral hazard model to the case when the agent's risk-aversion is his private information, so that the model also exhibits adverse selection. We characterize the optimal menu of contracts; while its detailed properties depend on the setting, we show that some of them must hold for all environments. In particular, the power of incentives always decreases with risk-aversion. We also characterize the relationship between the outside option and the optimal contracts. We then apply our results to insurance, managerial incentive pay and corporate governance.
Keywords: contracts; insurance
JEL Codes: D82
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| risk aversion (D81) | power of incentives (M52) |
| risk aversion (D81) | contract selection (K12) |
| contract selection (K12) | power of incentives (M52) |
| private risk aversion (D11) | optimal contract design (D86) |
| outside option characteristics (D43) | contract design (K12) |
| risk aversion and outside option characteristics (D81) | observed outcomes (C90) |