Article
On the Optimality of One-size-fits-all Contracts: The Limited Liability Case
International Journal of Game Theory
(2019)
Abstract
This paper studies a principal-agent relationship when both are risk-neutral and in the presence of adverse selection and moral hazard. Contracts must satisfy the limited-liability and monotonicity conditions. We provide sufficient conditions under which the optimal contract is simple, in the sense that each type is offered the same contract. These are: the action and the agent’s type are complements, and the output’s cumulative distribution function is such that the marginal rate of substitution between the action and the agent’s type is the same for each possible output realization. Furthermore, under the average monotone likelihood ratio property, the optimal contract is a call-option contract as in Innes (J Econ Theory 52(1):45–67, 1990). The results shed light on the fact that sometimes contracts are not highly dependent on individual characteristics as predicted in most pure moral hazard and pure adverse selection settings.
Keywords
- Moral Hazard,
- Adverse Selection,
- Limited Liability,
- Robustness,
- Contracts
Disciplines
Publication Date
Spring December 23, 2019
DOI
https://doi.org/10.1007/s00182-019-00700-5
Citation Information
Felipe Balmaceda. "On the Optimality of One-size-fits-all Contracts: The Limited Liability Case" International Journal of Game Theory Vol. 37 Iss. 4 (2019) p. 1 - 37 ISSN: Forthcoming Available at: http://works.bepress.com/felipe_balmaceda/11/