Flexible Moral Hazard Problems

Organised by

• Department of Economics

This paper considers a moral hazard problem where the agent can choose any output distribution with a support in a given compact set. The agent’s effort-cost is smooth and increasing in first-order stochastic dominance. To analyze this model, we develop a generalized notion of the first-order approach applicable to optimization problems over measures. We demonstrate that each output distribution can be implemented and identify those contracts which implement that distribution. Contracts are characterized by a simple first-order condition which equates the agent’s marginal cost of changing the implemented distribution with its marginal benefit. Furthermore, the agent’s wage is shown to be increasing in output. Finally, we consider the problem of a profit-maximizing principal and provide a first-order characterization of principal-optimal distributions.

Co-authors: George Georgiadis and Doron Ravid