Robustness and Linear Contracts

2015 ◽  
Vol 105 (2) ◽  
pp. 536-563 ◽  
Author(s):  
Gabriel Carroll
Keyword(s):  
Moral Hazard ◽  
Functional Form ◽  
Limited Liability ◽  
Optimal Contract ◽  
Worst Case ◽  
Modeling Approach ◽  
Flexible Modeling ◽  
Moral Hazard Problem

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)

Dynamic Moral Hazard and Risk-Shifting Incentives in a Leveraged Firm

2019 ◽  
Vol 55 (4) ◽  
pp. 1333-1367 ◽  
Author(s):  
Alejandro Rivera
Keyword(s):  
Moral Hazard ◽  
Empirical Studies ◽  
Risk Shifting ◽  
Optimal Contract ◽  
Positive Relation ◽  
Negative Relation ◽  
Moral Hazard Problem ◽  
Hazard And Risk ◽  
Incentive Constraint ◽  
Monotonic Relation

I develop an analytically tractable model that integrates the risk-shifting problem between bondholders and shareholders with the moral-hazard problem between shareholders and the manager. An optimal contract binds shareholders and the manager, and this contract’s flexibility allows shareholders to relax the manager’s incentive constraint following a “good” profitability shock. Thus, the optimal contract amplifies the upside and thereby increases shareholder appetite for risk shifting. Whereas some empirical studies find a positive relation between risk shifting and leverage, others find a negative relation. This model predicts a non-monotonic relation between risk shifting and leverage and can reconcile these contradictory empirical findings.

scholarly journals Controlling The Moral Hazard Created By Limiting Liability

2011 ◽  
Vol 12 (3) ◽  
pp. 9 ◽  
Author(s):  
Richard DeFusco ◽  
Paul Shoemaker ◽  
Nancy Stara
Keyword(s):  
Moral Hazard ◽  
Limited Liability ◽  
Accounting Firms ◽  
Joint And Several Liability ◽  
Moral Hazard Problem ◽  
Personal Liability

<span>Accounting firms may choose to organize either as Limited Liability Companies (LLC) or as Limited Liability Partnerships (LLP) to eliminate joint and several liability for their partners. However, before firms consider adopting either new entity form to limit tortuous liability, the moral hazard problem associated with these entity choices should be evaluated. This article examines the issue of accountant liability and offers suggestions to reduce moral hazard while still protecting the accountant from personal liability.</span>

Disclosure and Secrecy in Employee Monitoring

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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