Wealth effects and agency costs

Hector Chade, Virginia N. Vera de Serio

Research output: Contribution to journalArticlepeer-review

6 Scopus citations

Abstract

We analyze how the agent's initial wealth affects the principal's expected profits in the standard principal-agent model with moral hazard. We show that if the principal prefers a poorer agent for all specifications of action sets, probability distributions, and disutility of effort, then the agent's utility of income must exhibit a coefficient of absolute prudence less than three times the coefficient of absolute risk aversion for all levels of income, thus strengthening the sufficiency result of Thiele and Wambach (1999). Also, we prove that there is no condition on the agent's utility of income alone that will make the principal prefer richer agents. Moreover, we show that, for an interesting class of problems, the principal prefers a relatively poorer agent if agent's wealth is sufficiently large. Finally, we discuss how alternative ways of modeling the agent's outside option affects the principal's preferences for agent's wealth.

Original languageEnglish (US)
Pages (from-to)1-11
Number of pages11
JournalGames and Economic Behavior
Volume86
DOIs
StatePublished - Jul 2014

Keywords

  • Contracts
  • Moral hazard
  • Principal-agent model
  • Wealth effects

ASJC Scopus subject areas

  • Finance
  • Economics and Econometrics

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