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Optimal wage contracts under asymmetric information and moral hazard when investment decisions are delegated

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Abstract

I derive an optimal wage contract when risky investment decisions are delegated by riskaverse owners/investors to risk-neutral agents. The owners/investors do not know the probability distribution over the returns of any investment made by an agent. They know only the mean and the variance, and the upper and lower bounds of the return realizations of the different positive net present value (NPV) investment opportunities that can be discovered by their agents. They observe only the returns realized at the end of the period. Moral hazard with respect to investments made by agents, who are protected by limited liability, is also possible: an agent can falsely claim to have invested in one type of positive NPV investment opportunity and invest in another, or the agent can falsely claim to have invested in a positive NPV investment and invest in a negative NPV investment. I show that an optimal wage contract is simple under such conditions of severe asymmetric information and moral hazard. (JEL G20, G31)

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Authors and Affiliations

  1. Department of Banking and Finance, Case Western Reserve University, 10900 Euclid Avenue, 44106, Cleveland, OH

    C. N. V. Krishnan

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  1. C. N. V. Krishnan
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Correspondence to C. N. V. Krishnan.

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Krishnan, C.N.V. Optimal wage contracts under asymmetric information and moral hazard when investment decisions are delegated. J Econ Finan 31, 302–318 (2007). https://doi.org/10.1007/BF02885721

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