{"title":"Loss Aversion, Moral Hazard, and Stochastic Contracts","authors":"Hoa Ho","doi":"10.1002/mde.4459","DOIUrl":null,"url":null,"abstract":"<p>I examine whether stochastic contracts benefit the principal under moral hazard and loss aversion. Incorporating the agent's expectation-based loss aversion and allowing for stochastic contracts, I find that stochastic contracts reduce the principal's cost as compared with deterministic contracts. The optimal stochastic contract pays a high wage not only when good signals are realized but also with a positive probability after the realization of bad signals. The findings have an important implication for designing contracts for loss-averse agents: the principal should insure the agent against wage uncertainty by employing stochastic contracts that increase the probability of a high wage.</p>","PeriodicalId":18186,"journal":{"name":"Managerial and Decision Economics","volume":"46 3","pages":"1677-1685"},"PeriodicalIF":2.5000,"publicationDate":"2024-12-18","publicationTypes":"Journal Article","fieldsOfStudy":null,"isOpenAccess":false,"openAccessPdf":"https://onlinelibrary.wiley.com/doi/epdf/10.1002/mde.4459","citationCount":"0","resultStr":null,"platform":"Semanticscholar","paperid":null,"PeriodicalName":"Managerial and Decision Economics","FirstCategoryId":"96","ListUrlMain":"https://onlinelibrary.wiley.com/doi/10.1002/mde.4459","RegionNum":3,"RegionCategory":"经济学","ArticlePicture":[],"TitleCN":null,"AbstractTextCN":null,"PMCID":null,"EPubDate":"","PubModel":"","JCR":"Q2","JCRName":"ECONOMICS","Score":null,"Total":0}
引用次数: 0
Abstract
I examine whether stochastic contracts benefit the principal under moral hazard and loss aversion. Incorporating the agent's expectation-based loss aversion and allowing for stochastic contracts, I find that stochastic contracts reduce the principal's cost as compared with deterministic contracts. The optimal stochastic contract pays a high wage not only when good signals are realized but also with a positive probability after the realization of bad signals. The findings have an important implication for designing contracts for loss-averse agents: the principal should insure the agent against wage uncertainty by employing stochastic contracts that increase the probability of a high wage.
期刊介绍:
Managerial and Decision Economics will publish articles applying economic reasoning to managerial decision-making and management strategy.Management strategy concerns practical decisions that managers face about how to compete, how to succeed, and how to organize to achieve their goals. Economic thinking and analysis provides a critical foundation for strategic decision-making across a variety of dimensions. For example, economic insights may help in determining which activities to outsource and which to perfom internally. They can help unravel questions regarding what drives performance differences among firms and what allows these differences to persist. They can contribute to an appreciation of how industries, organizations, and capabilities evolve.