scholarly journals Optimal contracts with a risk‐taking agent

2020 ◽  
Vol 15 (2) ◽  
pp. 715-761 ◽  
Author(s):  
Daniel Barron ◽  
George Georgiadis ◽  
Jeroen Swinkels
Keyword(s):  
Risk Taking ◽  
Limited Liability ◽  
Risk Averse ◽  
Trade Off ◽  
Optimal Contracts ◽  
Risk Neutral ◽  
Profit Maximizing ◽  
Over Time

Consider an agent who can costlessly add mean‐preserving noise to his output. To deter such risk‐taking, the principal optimally offers a contract that makes the agent's utility concave in output. If the agent is risk‐neutral and protected by limited liability, this concavity constraint binds and so linear contracts maximize profit. If the agent is risk averse, the concavity constraint might bind for some outputs but not others. We characterize the unique profit‐maximizing contract and show how deterring risk‐taking affects the insurance‐incentive trade‐off. Our logic extends to costly risk‐taking and to dynamic settings where the agent can shift output over time.

scholarly journals Only Time Will Tell: A Theory of Deferred Compensation

2020 ◽  
Author(s):  
Florian Hoffmann ◽  
Roman Inderst ◽  
Marcus Opp
Keyword(s):  
Limited Liability ◽  
Optimal Timing ◽  
Deferred Compensation ◽  
Optimal Contracts ◽  
Clear Cut ◽  
Maturity Structure ◽  
Nature Of Information ◽  
Agent Characteristics ◽  
Informative Signals ◽  
Over Time

Abstract This article characterizes optimal compensation contracts in principal-agent settings in which the consequences of the agent’s action are only observed over time. The optimal timing of pay trades off the costs of deferred compensation arising from the agent’s relative impatience and potential consumption smoothing needs against the benefit of exploiting additional informative signals. By capturing this information benefit of deferral in terms of the likelihood ratio dynamics, our characterization covers general signal processes in a unified setting. With bilateral risk neutrality and agent limited liability, optimal contracts are high-powered and stipulate at most two payout dates. If the agent is additionally risk-averse, payouts are contingent on performance exceeding a hurdle that is increasing over time. We obtain clear-cut predictions on how the duration of optimal compensation depends on the nature of information arrival as well as agent characteristics and derive implications for the maturity structure of securities in financial contracting settings.

Contract Bargaining with a Risk-Averse Agent

2013 ◽  
Vol 13 (1) ◽  
pp. 285-301 ◽  
Author(s):  
Sanxi Li ◽  
Hao Xiao ◽  
Dongmin Yao
Keyword(s):  
Utility Function ◽  
Bargaining Power ◽  
Limited Liability ◽  
Bargaining Model ◽  
Risk Averse ◽  
Certainty Equivalents ◽  
The Social ◽  
Risk Neutral ◽  
Power Of Incentives ◽  
High Effort

AbstractThis article is the first to study a bargaining model in a moral hazard framework where the principal is risk neutral and the agent is risk averse. We show that the power of incentives increases with the agent’s bargaining power if the contracts induce a high effort. However, under reasonable assumptions about the agent’s utility function, the contracts induce a high effort less often as the agent’s bargaining power increases. As for the social welfare, we are surprised to find that a utilitarian, who cares about the sum of the two parties’ certainty equivalents, is worse off as the agent’s bargaining power increases. These results are in sharp contrast to the literature, which features risk-neutral agents protected by limited liability.

Regret-Based Decision-Making Style Acts as a Dispositional Factor in Risky Choices

2018 ◽  
Vol 122 (4) ◽  
pp. 1412-1431 ◽  
Author(s):  
Marco Lauriola ◽  
Angelo Panno ◽  
Joshua A. Weller
Keyword(s):  
Decision Making ◽  
Individual Differences ◽  
Risk Behaviors ◽  
Risk Taking ◽  
Anxiety And Depression ◽  
Risk Averse ◽  
Factorial Structure ◽  
Balloon Analogue Risk Task ◽  
Risk Taking Behaviors ◽  
Over Time

People who anticipate the potential regret of one’s decisions are believed to act in a more risk-averse manner and, thus, display fewer risk-taking behaviors across many domains. We conducted two studies to investigate whether individual differences in regret-based decision-making (a) reflect a unitary cognitive-style dimension, (b) are stable over time, and (c) predict later risk-taking behavior. In Study 1, 332 participants completed a regret-based decision-making style scale (RDS) to evaluate its psychometric qualities. In Study 2, participants ( N = 119) were tested on two separate occasions to assess the association between RDS and risk-taking. At Time 1, participants completed the RDS, as well as trait measures of anxiety and depression. One month later, they completed the Balloon Analogue Risk Task (BART) and state mood (Positive/Negative affect) scales. The RDS had a sound unidimensional factorial structure and was stable over time. Further, higher reported RDS scores were significantly associated with less risk-taking on the BART, holding other variables constant. These studies suggest that individual differences in regret-based decision-making may lead to a more cautious approach to real-world risk behaviors.

scholarly journals Capital requirements, risk-taking and welfare in a growing economy

2021 ◽  
Author(s):  
Pierre-Richard Agénor ◽  
Luiz A. Pereira da Silva
Keyword(s):  
Risk Taking ◽  
Default Risk ◽  
Limited Liability ◽  
Capital Requirements ◽  
Optimal Choice ◽  
Capital Adequacy ◽  
Financial Supervision ◽  
Capital Adequacy Ratio ◽  
Monitoring Effort ◽  
Growing Economy

AbstractThe effects of capital requirements on risk-taking and welfare are studied in an overlapping generations model of endogenous growth with banking, limited liability, and government guarantees. Capital producers face a choice between a safe technology and a risky, more productive but socially inefficient, technology. Bank risk-taking is endogenous. As a result of a skin in the game effect—motivated either as an aggregate externality, or as the outcome of the optimal choice of monitoring effort by individual banks—default risk is inversely related to the capital adequacy ratio. Numerical simulations show that in an equilibrium where banks extend both safe and risky loans, the skin in the game effect must be sufficiently strong for a welfare-maximizing regulatory policy to exist. These results remain qualitatively similar with endogenous monitoring costs and a strong effect of monitoring on entrepreneurial moral hazard. However, numerical experiments also suggest that the optimal capital adequacy ratio may be too high in practice and may require concomitantly a broadening of the perimeter of regulation and a strengthening of financial supervision to prevent disintermediation and distortions in financial markets.

scholarly journals OPTIMAL OUTCOME SHARING WITH A CONSORTIUM OF CONTRACTORS

2015 ◽  
Vol 22 (5) ◽  
pp. 655-665 ◽  
Author(s):  
S. Mahdi HOSSEINIAN ◽  
David G. CARMICHAEL
Keyword(s):  
Risk Aversion ◽  
Risk Attitude ◽  
Risk Averse ◽  
Optimal Outcome ◽  
Original Solution ◽  
Project Outcome ◽  
Risk Neutral ◽  
Current Practices

Where a consortium of contractors is involved, there exist no guidelines in the literature on what the outcome sharing arrangement should be. The paper addresses this shortfall. It derives the optimal outcome sharing arrangement for risk-neutral and risk-averse contractors within the consortium, and between the consortium and a risk-neutral owner. Practitioners were engaged in a designed exercise in order to validate the paper’s propositions. The paper demonstrates that, at the optimum: the proportion of outcome sharing among contractors with the same risk-attitude should reflect the levels of their contributions; the proportion of outcome sharing among contractors with the same level of contribu­tion should be lower for contractors with higher levels of risk aversion; a consortium of risk-neutral contractors should receive or bear any favourable or adverse project outcome respectively; and the proportion of outcome sharing to a con­sortium of risk-averse contractors should reduce, and the fixed component of the consortium fee should increase, when the contractors become more risk-averse or the level of the project outcome uncertainty increases. The paper proposes an original solution to the optimal sharing problem in contracts with a consortium of contractors, thereby contributing to current practices in contracts management.

The Moderating Role of Personal Relevance on Differential Priming of Anxiety and Sadness on Perceived Travel Risk: A Replication

2009 ◽  
Vol 104 (2) ◽  
pp. 500-508 ◽  
Author(s):  
Wen-Bin Chiou ◽  
Ming-Hsu Chang ◽  
Chien-Lung Chen
Keyword(s):  
Decision Making ◽  
Risk Taking ◽  
Personal Relevance ◽  
Risk Averse ◽  
Mood Repair ◽  
Neutral Mood ◽  
Motivational Influences ◽  
Relevance Condition ◽  
Moderating Role

Raghunathan and Pham conducted a pioneer study in 1999 on the motivational influences of anxiety and sadness on decision making and indicated that anxiety would motivate individuals to be risk averse, whereas sadness would motivate individuals to be risk taking. A replication study was employed in the domain of perceived travel risk. Compared to participants in a neutral mood, anxious participants showed higher perceived travel risk than sad participants. Moreover, the differential effect of anxiety and sadness on perceived travel risk was only pronounced under the high personal relevance condition, in which participants made personal decisions and expected that they would be affected by the outcomes. In general, the results extend the notion proposed by Raghunathan and Pham suggesting that travelers' implicit goals primed by anxiety or sadness used for mood-repair purposes appear to be moderated by personal relevance.

The stochastic Mitra–Wan forestry model: risk neutral and risk averse cases

2014 ◽  
Vol 115 (2) ◽  
pp. 175-194 ◽  
Author(s):  
Adriana Piazza ◽  
Bernardo K. Pagnoncelli
Keyword(s):  
Risk Averse ◽  
Model Risk ◽  
Risk Neutral

Cutoff Threshold Decisions for Classification Algorithms with Risk Aversion

2021 ◽  
Author(s):  
Andrea C. Hupman
Keyword(s):  
Risk Aversion ◽  
Risk Attitude ◽  
Classification Algorithm ◽  
Classification Algorithms ◽  
Risk Averse ◽  
Optimal Cutoff ◽  
Data Set ◽  
Risk Neutral ◽  
Bayes Algorithm ◽  
Cutoff Threshold

Classification algorithms predict the class membership of an unknown record. Methods such as logistic regression or the naïve Bayes algorithm produce a score related to the likelihood that a record belongs to a particular class. A cutoff threshold is then defined to delineate the prediction of one class over another. This paper derives analytic results for the selection of an optimal cutoff threshold for a classification algorithm that is used to inform a two-action decision in the cases of risk aversion and risk neutrality. The results provide insight to how the optimal cutoff thresholds relate to the associated costs and the sensitivity and specificity of the algorithm for both the risk neutral and risk averse decision makers. The optimal risk averse threshold is not reliably above or below the optimal risk neutral threshold, but the relation depends on the parameters of a particular application. The results further show the risk averse optimal threshold is insensitive to the size of the data set or the magnitude of the costs, but instead is sensitive to the proportion of positive records in the data and the ratio of costs. Numeric examples and sensitivity analysis derive further insight. Results show the percent value gap from a misspecified risk attitude increases as the specificity of the classification algorithm decreases.

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