Optimal Incentive Contracts Under Moral Hazard When the Agent is Free to Leave

53 Pages Posted: 6 Jul 2010

See all articles by Florian Englmaier

Florian Englmaier

Department of Economics; CESifo (Center for Economic Studies and Ifo Institute)

Gerd Muehlheusser

University of Hamburg; IZA Institute of Labor Economics

Andreas Roider

University of Regensburg - Department of Economics and Econometrics; IZA Institute of Labor Economics

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Abstract

We characterize optimal incentive contracts in a moral hazard framework extended in two directions. First, after effort provision, the agent is free to leave and pursue some ex-post outside option. Second, the value of this outside option is increasing in effort, and hence endogenous. Optimal contracts may entail properties such as inducing first-best effort and surplus, or non-responsiveness with respect to changes in verifiable parameters. Moreover, while always socially inefficient, separation might occur in equilibrium. Except for the latter, these findings are robust to renegotiation. When the outside option is exogenous instead, the standard results obtain.

Keywords: moral hazard, limited commitment, ex-post outside option, limited liability

JEL Classification: D86, D82, K31, M52

Suggested Citation

Englmaier, Florian and Muehlheusser, Gerd and Roider, Andreas, Optimal Incentive Contracts Under Moral Hazard When the Agent is Free to Leave. IZA Discussion Paper No. 5027. Available at SSRN: https://ssrn.com/abstract=1634494

Florian Englmaier (Contact Author)

Department of Economics ( email )

Ludwigstrasse 28
Munich, D-80539
Germany

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Gerd Muehlheusser

University of Hamburg ( email )

Von Melle Park 5
Hamburg, 20146
Germany

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Andreas Roider

University of Regensburg - Department of Economics and Econometrics ( email )

Universitaetsstrasse 31
D-93040 Regensburg
Germany

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

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