Optimal Incentive Contracts under Moral Hazard When the Agent is Free to Leave

Englmaier, Florian and Muehlheusser, Gerd and Roider, Andreas (July 2010): Optimal Incentive Contracts under Moral Hazard When the Agent is Free to Leave. SFB/TR 15 Discussion Paper No. 329

Abstract

We characterize optimal incentive contracts in a moral hazard framework extended in two directions. First, after effort provision, the agent is free to leave and pursue some ex-post outside option. Second, the value of this outside option is increasing in effort, and hence endogenous. Optimal contracts may entail properties such as inducing first-best effort and surplus, or non-responsiveness with respect to changes in verifiable parameters. Moreover, while always socially inefficient, separation might occur in equilibrium. Except for the latter, these findings are robust to renegotiation. When the outside option is exogenous instead, the standard results obtain.

• Item Type: Paper (Discussion Paper)
• Keywords: moral hazard, limited commitment, ex-post outside option, limited liability
• Collections: Special Research Fields > Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems; Special Research Fields > Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems > A4 - Unvollständige Verträge, Marktinteraktion und soziale Vergleichsprozesse
• Subjects: 300 Social sciences > 330 Economics
• JEL Classification: D86, D82, K31, M52
• Language: English