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Games 2018, 9(1), 12; https://doi.org/10.3390/g9010012

The Optimal Contract under Adverse Selection in a Moral-Hazard Model with a Risk-Averse Agent

CRESE EA3190, University Bourgogne Franche-Comté, F-25000 Besançon, France
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Received: 13 November 2017 / Revised: 14 February 2018 / Accepted: 21 February 2018 / Published: 1 March 2018
(This article belongs to the Special Issue Contracts, Incentives and Information: Theory and Evidence)
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Abstract

This paper studies the optimal contract offered by a risk-neutral principal to a risk-averse agent when the agent’s hidden ability and action both improve the probability of the project being successful. We show that if the agent is sufficiently prudent and able, the principal induces a higher probability of success than under moral hazard, despite the costly informational rent given up. Moreover, there is distortion at the top. Finally, the conditions to avoid pooling are difficult to satisfy because of the different kinds of incentives to be managed and the overall trade-off between rent extraction, insurance, and efficiency involved. View Full-Text
Keywords: adverse selection; moral hazard; risk aversion; prudence adverse selection; moral hazard; risk aversion; prudence
This is an open access article distributed under the Creative Commons Attribution License which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited (CC BY 4.0).
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Maréchal, F.; Thomas, L. The Optimal Contract under Adverse Selection in a Moral-Hazard Model with a Risk-Averse Agent. Games 2018, 9, 12.

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