Hidden Action and Outcome Contractibility: An Experimental Test of Moral Hazard Theory
67 Pages Posted: 21 Aug 2019
Date Written: 2018
In a laboratory experiment with 754 participants, we study the canonical one-shot moral hazard problem, comparing treatments with unobservable effort to benchmark treatments with verifiable effort. In our experiment, the players endogenously negotiate contracts. In line with contract theory, the contractibility of the outcome plays a crucial role when effort is a hidden action. If the outcome is contractible, most players overcome the hidden action problem by agreeing on incentive-compatible contracts. Communication is helpful, since it may reduce strategic uncertainty. If the outcome is non-contractible, in most cases low effort is chosen whenever effort is a hidden action. However, communication leads the players to agree on larger wages and substantially mitigates the underprovision of effort.
Keywords: Moral hazard, Hidden action, Contract theory, Incentive theory, Laboratory experiments
JEL Classification: D86, D82, C72, C92
Suggested Citation: Suggested Citation