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A Note on Moral Hazard and Linear Compensation Schemes

dc.contributor.author Wang, XY
dc.date.accessioned 2016-12-06T00:40:49Z
dc.date.issued 2013-07-18
dc.identifier.uri https://hdl.handle.net/10161/13172
dc.description.abstract This note identifies a moral hazard environment in which a piecewise linear compensation scheme is optimal. Both the principal and the agent have CARA utility, mean output is increasing in the agent's non-contractible input, and output is distributed according to a Laplace distribution, which resembles a normal distribution (e.g. it is symmetric about the mean), but has fatter tails. The key property of the Laplace distribution is that the likelihood ratio is a piecewise constant, where the discontinuity occurs at the mean. The value of this approach is twofold: First, a tractable, empirically-observed wage scheme emerges as the equilibrium in a simple static contracting model. Second, the optimal piecewise linear scheme cleanly separates insurance and incentive provision. The linearity at output levels away from the mean captures insurance, while the jump at the mean captures incentive provision. Hence, this model is well-suited for studying a wide variety of principal-agent problems in risky environments subject to moral hazard, such as the effect of risk and moral hazard considerations on employment relationships in developing economies.
dc.relation.ispartof Economic Research Initiatives at Duke (ERID) Working Paper
dc.subject principal agent problems
dc.subject moral hazard
dc.subject linear incentive schemes
dc.subject insurance
dc.subject incentives
dc.title A Note on Moral Hazard and Linear Compensation Schemes
dc.type Journal article
pubs.issue 160
pubs.notes Source info: Economic Research Initiatives at Duke (ERID) Working Paper No. 160
pubs.organisational-group Duke
pubs.organisational-group Economics
pubs.organisational-group Trinity College of Arts & Sciences


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