Abstract
We study the moral-hazard problem when the agent's reservation utility is large, but so is the agent's value to the principal. We show that the principal's cost of implementing effort has a very simple limiting form. For large enough outside option, the principal's cost is convex in the action, so the optimally-implemented action is unique, and optimal effort rises with the agent's ability, and falls with the agent's wealth and outside option. In a competitive market setting where heterogenous principals and agents match, positive sorting ensues and effort increases in match quality, despite conflicting forces.
Original language | English (US) |
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Article number | 105032 |
Journal | Journal of Economic Theory |
Volume | 187 |
DOIs | |
State | Published - May 2020 |
Keywords
- Comparative statics
- First-order approach
- Matching
- Moral hazard
- Principal-agent problem
ASJC Scopus subject areas
- Economics and Econometrics