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‘Incentive conscious’ agents and moral hazard

  • Oindrila Dey
  • Swapnendu BanerjeeEmail author
Article
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Abstract

This paper characterizes the structure of monetary incentives with varying agent incentive-consciousness. Incentive consciousness arises when the valuation of incentive among agents differs with situations. Using a moral hazard framework with limited liability we show that for agents with low outside option optimal incentive pay is independent of incentive-consciousness whereas for agents with high outside option increased incentive-consciousness leads to increased incentive payment. For agents with very high incentive-consciousness such that the limited liability does not bind, an exogenous increase in incentive-consciousness leads to an unambiguous decrease in optimal incentive payment. Thus, the paper provides a non-monotonic relation between incentive consciousness and optimal incentive pay. With incentive-consciousness, inefficiency in the effort will exist with risk-neutral principal and agent even in the absence of limited liability. This runs contrary to standard incentive theory.

Keywords

Incentive-consciousness Incentives Moral hazard Optimal contract 

JEL Classifications

D86 L20 

Notes

Acknowledgements

We thank an anonymous referee of his/her insightful comments that led to substantial improvement in the quality of the paper. We also thank the Editor of the journal, Prof. Uday Bhanu Sinha for giving us the opportunity to revise and resubmit the paper. This paper was completed when the second author was visiting the London School of Economics in 2016. Financial support from Subir Chowdhury Foundation during the stay is gratefully acknowledged. This paper draws its inspiration from the first author’s Ph.D. dissertation submitted to Jadavpur University in 2015 (awarded the same year). We are responsible for any remaining errors.

Compliance with ethical standards

Conflict of interest

On behalf of the authors, the corresponding author states that there is no conflict of interest.

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Web-material

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Copyright information

© Editorial Office, Indian Economic Review 2019

Authors and Affiliations

  1. 1.Department of EconomicsFLAME UniversityPuneIndia
  2. 2.Department of EconomicsJadavpur UniversityKolkataIndia

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