Moral Hazard and Bargaining Over Incentive Contracts

21 Pages Posted: 21 Aug 2014

See all articles by Marcus Dittrich

Marcus Dittrich

Deggendorf Institute of Technology; CESifo (Center for Economic Studies and Ifo Institute)

Silvio Staedter

University of Regensburg

Date Written: July 31, 2014

Abstract

This paper analyses bargaining over an incentive compatible contract in a moral hazard framework. We introduce the Kalai-Smorodinsky bargaining solution and compare the outcome with the commonly applied Nash solution. Whether worker’s effort is higher in the Nash or the Kalai-Smorodinsky solution depends on the agents. bargaining power. If agents have equal bargaining power, the contract in the Kalai-Smorodinsky solution yields a more efficient outcome and induces more effort. The social planner can mitigate inefficiencies arising in both bargaining solutions from the moral hazard problem and even achieve the first-best outcome by allocating the agents’ bargaining power. If raising the worker’s bargaining power is necessary to achieve the first-best solution, this increase must be higher in the Nash solution than in the Kalai-Smorodinsky solution.

Keywords: incentive contracts, moral hazard, Nash bargaining solution, Kalai-Smorodinsky solution, bargaining power

JEL Classification: C710, D820, J410

Suggested Citation

Dittrich, Marcus and Staedter, Silvio, Moral Hazard and Bargaining Over Incentive Contracts (July 31, 2014). CESifo Working Paper Series No. 4920. Available at SSRN: https://ssrn.com/abstract=2483652

Marcus Dittrich (Contact Author)

Deggendorf Institute of Technology ( email )

Edlmairstraße 6 und 8
Deggendorf, Bavaria 94469
Germany

CESifo (Center for Economic Studies and Ifo Institute) ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

Silvio Staedter

University of Regensburg ( email )

93040 Regensburg
D-93040 Regensburg, 93053
Germany

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