Working Paper: CEPR ID: DP6011
Authors: Pierre Dubois; Tomislav Vukina
Abstract: The objective of this paper is to develop an analytical framework for estimation of the parameters of a structural model of an incentive contract under moral hazard, taking into account agents heterogeneity in preferences. We show that allowing the principal to strategically distribute the production inputs across heterogenous agents as part of the contract design, the principal is able to change what appears to be a uniform contract into individualized contracts tailored to fit agents' preferences or characteristics. Using micro level data on swine production contract settlements, we find that contracting farmers are heterogenous with respect to their risk aversion and that this heterogeneity affects the principal's allocation of production inputs across farmers. Relying on the identifying assumption that contracts are optimal, we obtain the estimates of a lower and an upper bound of agents' reservation utilities. We show that farmers with higher risk aversion have lower outside opportunities because of lower reservation utilities.
Keywords: agency contracts; heterogeneity; moral hazard; optimal incentives; risk aversion
JEL Codes: D82; K32; L24
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| risk aversion (D81) | contract design (K12) |
| contract design (K12) | allocation of production inputs (D24) |
| risk aversion (D81) | allocation of production inputs (D24) |
| risk aversion (D81) | outside opportunities (O36) |
| outside opportunities (O36) | reservation utilities (L97) |
| allocation of production inputs (D24) | revenues (H27) |
| risk aversion (D81) | optimal effort exerted by growers (Q12) |
| optimal effort exerted by growers (Q12) | contract design decisions (D47) |