Optimal Incentive Contracting with Ex Ante and Ex Post Moral Hazards: Theory and Evidence

J. OF RISK AND UNCERTAINTY, Vol. 14 No. 2

Posted: 3 Mar 1997

See all articles by Robert Puelz

Robert Puelz

Southern Methodist University (SMU) - Real Estate, Insurance, & Business Law Department

Arthur Snow

University of Georgia - C. Herman and Mary Virginia Terry College of Business - Department of Economics

Abstract

Predictions concerning structure and performance for managerial incentive contracts designed to prevent accidents are developed and tested. The model predicts a step-function penalty with more costly, more reliable audits used for higher loss reports to control ex post exaggeration of the loss. In addition, the penalty induces nonreporting that is imperfectly controlled through random audits. An empirical contract implemented to control workers' compensation medical losses provides evidence consistent with these predictions. The contract reduces both accident frequency and total losses, but increases reported loss severity as managers evade approximately 40 percent of the accident penalty by underreporting small losses.

JEL Classification: D82, G22

Suggested Citation

Puelz, Robert and Snow, Arthur, Optimal Incentive Contracting with Ex Ante and Ex Post Moral Hazards: Theory and Evidence. J. OF RISK AND UNCERTAINTY, Vol. 14 No. 2. Available at SSRN: https://ssrn.com/abstract=8152

Robert Puelz (Contact Author)

Southern Methodist University (SMU) - Real Estate, Insurance, & Business Law Department ( email )

United States
214-768-4156 (Phone)
214-768-3713 (Fax)

Arthur Snow

University of Georgia - C. Herman and Mary Virginia Terry College of Business - Department of Economics ( email )

Athens, GA 30602-6254
United States
706-542-3752 (Phone)

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