Hidden Action and Outcome Contractibility: An Experimental Test of Moral Hazard Theory

67 Pages Posted: 21 Aug 2019

See all articles by Eva I. Hoppe

Eva I. Hoppe

University of Cologne - Department of Economics

Patrick W. Schmitz

University of Cologne; Centre for Economic Policy Research (CEPR)

Date Written: 2018

Abstract

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

Hoppe, Eva I. and Schmitz, Patrick W., Hidden Action and Outcome Contractibility: An Experimental Test of Moral Hazard Theory (2018). Games and Economic Behavior, Vol. 109, 2018, pp. 544-564. Available at SSRN: https://ssrn.com/abstract=3421046

Eva I. Hoppe

University of Cologne - Department of Economics ( email )

Cologne, 50923
Germany

Patrick W. Schmitz (Contact Author)

University of Cologne ( email )

Albertus-Magnus-Platz
Cologne, 50923
Germany

HOME PAGE: http://schmitz.uni-koeln.de/index.php?s=mitarbeiter&t=schmitz

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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