On Incentives, Temptation and Self-Control

20 Pages Posted: 14 Mar 2014 Last revised: 5 Jan 2015

See all articles by Lukasz Patryk Wozny

Lukasz Patryk Wozny

Warsaw School of Economics - Quantitative Economics Department

Date Written: December 2014

Abstract

We consider a principal-agent model, where a single agent exhibits problems of self control modelled using Gul, Pesendorfer (2001) type temptation preferences. For a general class of preferences, yet specific family of temptation utilities, we characterize an optimal contract in such a setting using standard Grossman, Hart (1983) techniques. Firstly, our analysis shows that contrary to standard results for the separable utility the first best solution may provide a variable pay. Secondly, in the second best the incentive compatibility constraint is not ecessarily binding. Both results from the fact that in our setting principal trade-offs incentives and insurance but also reduction of self control costs for the agent. Our new results shed some light on the justification of randomized contracts (see Holmstrom 1979), the literature on behavioral contracts, but also show that in the presence of strong self-control costs both first and second best coincide, and moral hazard cost is mitigated.

Keywords: self-control costs, temptation, principal-agent, optimal contract, randomized contracts, behavioral contracts

JEL Classification: D82

Suggested Citation

Wozny, Lukasz Patryk, On Incentives, Temptation and Self-Control (December 2014). Available at SSRN: https://ssrn.com/abstract=2408206 or http://dx.doi.org/10.2139/ssrn.2408206

Lukasz Patryk Wozny (Contact Author)

Warsaw School of Economics - Quantitative Economics Department ( email )

Warsaw
Poland

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