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Article: Optimal Contract under Double Moral Hazard and Limited Liability
Title | Optimal Contract under Double Moral Hazard and Limited Liability |
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Authors | |
Keywords | Double moral hazard Limited liability Optimal contract |
Issue Date | 2021 |
Publisher | Springer Wien. The Journal's web site is located at http://www.springer.com/economics/journal/712 |
Citation | Journal of Economics, 2021, v. 134 n. 1, p. 49-71 How to Cite? |
Abstract | This paper investigates optimal contracts between risk-neutral parties when both exert efforts and the agent faces limited liability. We identify a sufficient and necessary condition for any contract to implement the second-best outcome, i.e., the best possible outcome in double moral hazard even when the agent faces unlimited liability. It is shown that a simple share-or-nothing with bonus contract (SonBo for short) is optimal and implements the second-best outcome when the condition holds. SonBo contracts have one degree of freedom, which is very useful in dealing with heterogeneous circumstances while still maintaining consistency in contracting. SonBo admits as special cases the option-like and step bonus contracts, which are widely used in dealing with limited liability. Nevertheless, we demonstrate that a step bonus contract is more powerful because an option-like contract can be problematic in some situations. The paper also discusses the performance of SonBo when the principal also faces liability constraint and investigates the optimal contract when the second-best outcome is not achievable. |
Persistent Identifier | http://hdl.handle.net/10722/307811 |
ISSN | 2023 Impact Factor: 1.6 2023 SCImago Journal Rankings: 0.413 |
ISI Accession Number ID |
DC Field | Value | Language |
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dc.contributor.author | Cong, J | - |
dc.contributor.author | Zhou, W | - |
dc.date.accessioned | 2021-11-12T13:38:15Z | - |
dc.date.available | 2021-11-12T13:38:15Z | - |
dc.date.issued | 2021 | - |
dc.identifier.citation | Journal of Economics, 2021, v. 134 n. 1, p. 49-71 | - |
dc.identifier.issn | 0931-8658 | - |
dc.identifier.uri | http://hdl.handle.net/10722/307811 | - |
dc.description.abstract | This paper investigates optimal contracts between risk-neutral parties when both exert efforts and the agent faces limited liability. We identify a sufficient and necessary condition for any contract to implement the second-best outcome, i.e., the best possible outcome in double moral hazard even when the agent faces unlimited liability. It is shown that a simple share-or-nothing with bonus contract (SonBo for short) is optimal and implements the second-best outcome when the condition holds. SonBo contracts have one degree of freedom, which is very useful in dealing with heterogeneous circumstances while still maintaining consistency in contracting. SonBo admits as special cases the option-like and step bonus contracts, which are widely used in dealing with limited liability. Nevertheless, we demonstrate that a step bonus contract is more powerful because an option-like contract can be problematic in some situations. The paper also discusses the performance of SonBo when the principal also faces liability constraint and investigates the optimal contract when the second-best outcome is not achievable. | - |
dc.language | eng | - |
dc.publisher | Springer Wien. The Journal's web site is located at http://www.springer.com/economics/journal/712 | - |
dc.relation.ispartof | Journal of Economics | - |
dc.rights | This version of the article has been accepted for publication, after peer review (when applicable) and is subject to Springer Nature’s AM terms of use, but is not the Version of Record and does not reflect post-acceptance improvements, or any corrections. The Version of Record is available online at: http://dx.doi.org/10.1007/s00712-021-00737-9 | - |
dc.subject | Double moral hazard | - |
dc.subject | Limited liability | - |
dc.subject | Optimal contract | - |
dc.title | Optimal Contract under Double Moral Hazard and Limited Liability | - |
dc.type | Article | - |
dc.identifier.email | Zhou, W: wzhou@hku.hk | - |
dc.identifier.authority | Zhou, W=rp01128 | - |
dc.description.nature | postprint | - |
dc.identifier.doi | 10.1007/s00712-021-00737-9 | - |
dc.identifier.scopus | eid_2-s2.0-85103407368 | - |
dc.identifier.hkuros | 330386 | - |
dc.identifier.volume | 134 | - |
dc.identifier.issue | 1 | - |
dc.identifier.spage | 49 | - |
dc.identifier.epage | 71 | - |
dc.identifier.isi | WOS:000636198300001 | - |
dc.publisher.place | Austria | - |