Optimal Contract Under Double Moral Hazard and Limited Liability

15 Pages Posted: 9 Jun 2020

See all articles by Jiajia Cong

Jiajia Cong

School of Management, Fudan University

Wen Zhou

University of Hong Kong

Date Written: May 13, 2020

Abstract

This paper investigates optimal contracts between risk-neutral parties when both exert efforts and the agent faces limited liability. It is shown that a simple share-or-nothing with bonus contract (SonBo for short) is optimal and implements the second-best outcome, i.e., the best possible outcome in double moral hazard even when the agent faces unlimited liability. No other contract can do better than SonBo. SonBo contracts have one degree of freedom, which is useful in dealing with heterogeneous circumstances while still maintaining consistency in contracting. Between the two instruments of SonBo, the bonus component is more important than the output share.

Keywords: Double Moral Hazard, Limited Liability, Optimal Contract

JEL Classification: D82, D86

Suggested Citation

Cong, Jiajia and Zhou, Wen, Optimal Contract Under Double Moral Hazard and Limited Liability (May 13, 2020). Available at SSRN: https://ssrn.com/abstract=3600741 or http://dx.doi.org/10.2139/ssrn.3600741

Jiajia Cong (Contact Author)

School of Management, Fudan University ( email )

670 Guoshun Road
Yangpu District
Shanghai
China

Wen Zhou

University of Hong Kong ( email )

1225 KKL Building
Pokfulam Road
Hong Kong
China

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
23
Abstract Views
202
PlumX Metrics