Moral hazard with limited liability: Random-variable formulation and optimal contract structures

We consider a moral hazard problem where the principal is uncertain as to what the agent can and cannot do: she knows some actions available to the agent, but other, unknown actions may also exist. The principal demands robustness, evaluating possible contracts by their worst-case performance, over unknown actions the agent might potentially take. The model assumes risk-neutrality and limited liability, and no other functional form assumptions. Very generally, the optimal contract is linear. The model thus offers a new explanation for linear contracts in practice. It also introduces a flexible modeling approach for moral hazard under nonquantifiable uncertainty. (JEL D81, D82, D86)

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Moral Hazard with Limited Liability: Incentive Contracting Under Monotone Ratio Assumptions

SSRN Electronic Journal ◽

10.2139/ssrn.1954916 ◽

2011 ◽

Author(s):

Wenbin Wang ◽

Shanshan Hu ◽

Xinxin Hu

Keyword(s):

Moral Hazard ◽

Limited Liability ◽

Incentive Contracting

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Disclosure and Secrecy in Employee Monitoring

Journal of Management Accounting Research ◽

10.2308/jmar.2010.22.1.187 ◽

2010 ◽

Vol 22 (1) ◽

pp. 187-208

Author(s):

Mitchell A. Farlee

Keyword(s):

Risk Aversion ◽

Moral Hazard ◽

Monitoring System ◽

Risk Premium ◽

Risk Sharing ◽

Limited Liability ◽

Efficient Production ◽

System A ◽

Liability Risk ◽

Employee Monitoring

ABSTRACT: Disclosure and monitoring policy are studied, where disclosure relates to information about the monitoring system. A moral hazard model is presented where employee monitoring occurs with some exogenous probability and the owner privately learns whether he will be monitoring before the employee chooses his productive action. Disclosure policy is an owner choice between revealing to the employee whether he will be monitoring before the action (Disclosure) or remaining silent (Secrecy). The results rely on the joint presence of risk aversion and limited liability. Risk aversion creates an efficiency/risk tradeoff where secrecy obtains risk-sharing benefits. Limited liability reduces these benefits, allowing preference for disclosure. Lower monitoring probabilities increase the risk premium required to obtain effort with secrecy. For small monitoring probabilities, disclosure is preferred even though less efficient production is achieved, because disclosure provides a greater risk-sharing benefit. For high monitoring probabilities, secrecy is preferred because it leads to greater efficiency despite a greater risk premium.

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