Moral Hazard: Base Models and Two Extensions

• Authors: David Pérez-Castrillo.
• BSE Working Paper: 110356 | February 16
• Keywords: matching , moral hazard , behavioral approach
• JEL codes: D86, D03, C78
• matching
• moral hazard
• behavioral approach

We analyze the optimal contract in static moral hazard situations, where the agent’s effort is not veri…able. We fi…rst present the main trade-offs of the principal-agent model. We cover the trade-off of incentives (motivation) vs. risk-sharing (efficiency), incentives vs. rents (when the agent is protected by limited liability), incentives to a task vs. incentives to another (in a multitask situation), and incentives to the agent vs. incentives to the principal (when both exert a non-veri…able effort). Then, we discuss two recent extensions: how incorporating behavioral biases in the analysis of incentives affects the predictions of the classical moral hazard model, and the insertion of the principal-agent problem in a matching market.