Optimal Incentive Contracts with Job Destruction Risk
Optimal Incentive Contracts with Job Destruction Risk

Author: Borys Grochulski

Publisher:

Published: 2017

Total Pages: 0

ISBN-13:

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We study the implications of job destruction risk for optimal incentives in a long-term contract with moral hazard. We extend the dynamic principal-agent model of Sannikov (2008) by adding an exogenous Poisson shock that makes the match between the firm and the agent permanently unproductive. In modeling job destruction as an exogenous Poisson shock, we follow the Diamond-Mortensen-Pissarides search-and-matching literature. The optimal contract shows how job destruction risk is shared between the rm and the agent. Arrival of the job-destruction shock is always bad news for the rm but can be good news for the agent. In particular, under weak conditions, the optimal contract has exactly two regions. If the agent's continuation value is below a threshold, the agent's continuation value experiences a negative jump upon arrival of the job-destruction shock. If the agent's value is above this threshold, however, the jump in the agent's continuation value is positive, i.e., the agent gets rewarded when the match becomes unproductive. This pattern of adjustment of the agent's value at job destruction allows the firm to reduce the costs of effort incentives while the match is productive. In particular, it allows the firm to adjust the drift of the agent's continuation value process so as to decrease the risk of reaching either of the two inefficient agent retirement points. Further, we study the sensitivity of the optimal contract to the arrival rate of job destruction.

Incentive Contracts and Downside Risk Sharing
Incentive Contracts and Downside Risk Sharing

Author: Bernard Sinclair-Desgagne

Publisher:

Published: 2017

Total Pages: 30

ISBN-13:

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This paper seeks to characterize incentive compensation in a static principal-agent moral hazard setting in which both the principal and the agent are prudent (or downside risk averse). We show that optimal incentive pay should then be `approximately concave' in performance, the approximation being closer the more downside risk averse the principal is compared to the agent. Limiting the agent's liability would improve the approximation, but taxing the principal would make it coarser. The notion of an approximately concave function we introduce here to describe optimal contracts is relatively recent in mathematics; it is intuitive and translates into concrete empirical implications, notably for the composition of incentive pay packages. We also clarify which measure of prudence - among the various ones proposed in the literature - is relevant to investigate the tradeoff between downside risk sharing and incentives.

Incentive Contracts and Efficiency in a Frictional Market
Incentive Contracts and Efficiency in a Frictional Market

Author: Benoit Julien

Publisher:

Published: 2019

Total Pages: 40

ISBN-13:

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Principals seek to trade with agents by posting incentive contracts in a search environment. A contract solves the ex ante search problem, and adverse selection and moral hazard ex post. We fully characterise the equilibrium for quasi linear preferences, and derive some comparative statics. If using appropriate transfers the equilibrium allocation is constrained welfare optimal, in contrast to the one-to-one principal-agent problem. Search frictions thus correct that inefficiency because searching requires internalizing the utility of agents. Incentives are weaker than in bilateral contracting, and agents enjoy more efficient risk sharing. With a constraint on transfers search and moral hazard interact and may induce an inefficient allocation; principal competition results in over-insurance of the agents and too little effort in equilibrium.

Adverse Selection and Moral Hazard in Contract Law
Adverse Selection and Moral Hazard in Contract Law

Author: Nicole Petrick

Publisher: GRIN Verlag

Published: 2009

Total Pages: 25

ISBN-13: 3640394127

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Essay aus dem Jahr 2005 im Fachbereich BWL - Recht, Note: 1,7, Higher School of Economics Moscow, Russia, Sprache: Deutsch, Abstract: Legal and economical interpretations of contract, contract law and contract theory, asymmetric information, adverse selection and moral hazard. Paper explains negative effects of adverse selection and moral hazard for the case of transaction costs and incomplete contracts and describes incentives to avoid adverse selection and moral hazard, such as signaling and deductibles as well as indemnity contracts and valued contracts.

Optimal Contracts Under Adverse Selection and Moral Hazard
Optimal Contracts Under Adverse Selection and Moral Hazard

Author:

Publisher:

Published: 2010

Total Pages:

ISBN-13:

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This article presents a continuous-time agency model in the presence of adverse selection and moral hazard with a risk-averse agent and a risk-neutral principal. Under the model setup, we show that the optimal controls are constant over time, and thus the optimal menu consists of contracts that are linear in the final outcome. We also show that when a moral hazard problem adds to an adverse selection problem, the monotonicity condition well known in the pure adverse selection literature needs to be modified to ensure the incentive compatibility for information revelation. The model is applied to a few managerial compensation problems involving managerial project selection and capital budgeting decisions. We argue that in the third-best world, the relationship between the volatility of the outcome and the sensitivity of the contract depends on interactions between the managerial cost and the firm`s production functions. Contrary to conventional wisdom, sometimes the higher the volatility, the higher the sensitivity of the contract. The firm receiving good news sometimes chooses safer projects or invests less than it does with bad news. We also examine the effects of the observability of the volatility on corporate investment decisions.

Optimal Contracting with Moral Hazard and Cascading
Optimal Contracting with Moral Hazard and Cascading

Author: Naveen Khanna

Publisher:

Published: 1998

Total Pages:

ISBN-13:

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In this paper I identify optimal incentive contracts for managers of firms competing in the product market. Such firms often confront similar decisions and uncertainties. Managers can improve decision quality by generating private signals through costly effort. However, since signals are likely to be correlated, firms that decide later get additional information from the actions of earlier firms. This impacts effort choice. Decision quality is also affected if later managers disregard their own signals and blindly imitate preceding decisions. In a competitive environment, such cascading hurts profits. Contracts that solve both moral hazard and cascading problems typically put more weight on firm profits, making them expensive. Contracts with more weight on decision quality are less expensive but result in cascades. Shareholders choose contracts that maximize their net surplus. This results in testable implications about which industries may have more convergence in investment choices, greater pay-for-profit sensitivity, larger differences in observed contracts, more innovation, larger-sized firms, and potential for over-compensation.