Moral Hazard: Base Models and Two Extensions

Abstract

We analyze the optimal contract in static moral hazard situations, where the agent’s effort is not verifiable. We first present the main trade-offs of the principal-agent model. We cover the trade-off of incentives (motivation) vs. risk-sharing (efficiency), incentives vs. rents (when the agent is protected by limited liability), incentives to a task vs. incentives to another (in a multitask situation), and incentives to the agent vs. incentives to the principal (when both exert a non-verifiable effort). Then, we discuss two recent extensions: how incorporating behavioral biases in the analysis of incentives affects the predictions of the classical moral hazard model, and the insertion of the principal-agent problem in a matching market.

Keywords: moral hazard, behavioral approach, matching

JEL Classification: D860, D030, C780