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Simple contracts under observable and hidden actions

  • Bo ChenEmail author
  • Yu Chen
  • David Rietzke
Research Article

Abstract

We consider a general framework for multitask moral hazard problems with observable and hidden actions. Ideally, the principal in our framework can design optimal contracts that depend on both observable (and verifiable) actions and realized outcomes. Given a mild assumption on the existence of a punishment scheme, we identify a general equivalence result, dubbed the “forcing principle,” which states that every optimal contract in our framework is strategically equivalent to a simple forcing contract, which only specifies an outcome-contingent reward scheme and an action profile, and the agent receives the outcome-contingent reward only if he follows the recommended observable actions (and is otherwise punished severely). The forcing principle has useful implications: it confers analytical advantage for the existence and computation of optimal contracts in our setting. It also highlights and makes explicit the importance of the existence of the punishment scheme in characterizing first-best benchmarks in moral hazard problems.

Keywords

First-best benchmark Forcing contract Forcing principle Moral hazard Observable actions 

JEL Classification

C61 C62 D86 

Notes

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Copyright information

© Springer-Verlag GmbH Germany, part of Springer Nature 2019

Authors and Affiliations

  1. 1.Department of EconomicsSouthern Methodist UniversityDallasUSA
  2. 2.Department of EconomicsUniversity of GrazGrazAustria
  3. 3.Department of EconomicsLancaster UniversityLancasterUK

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