Leonidas Enrique de la Rosa, Nikolaj Niebuhr Lambertsen
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Overconfidence and moral hazard without commitment
We examine the implications of overconfidence in a moral hazard setting with limited commitment. Limited commitment is costly because the principal will always renegotiate to the optimal risk-sharing contract after the agent chooses his effort level. This means that no effort level above the minimum can be implemented in pure strategies when the principal and the agent have homogeneous beliefs. With overconfidence, the optimal risk-sharing contract provides payments that increase in outcome to exploit the agent’s overconfidence. The agent anticipates the exploitative contract and willingly chooses higher than minimum effort in equilibrium. Providing the agent rent can increase the slope of the optimal risk-sharing contract and, therefore, expand the set of implementable effort levels. In a mixed-strategy equilibrium, overconfidence simultaneously decreases the risk in the second-best contract and increases the risk in the optimal risk-sharing contract, increasing the probability of high effort in equilibrium.
期刊介绍:
The primary objective of the Journal is to provide a forum for work in economic theory which expresses economic ideas using formal mathematical reasoning. For work to add to this primary objective, it is not sufficient that the mathematical reasoning be new and correct. The work must have real economic content. The economic ideas must be interesting and important. These ideas may pertain to any field of economics or any school of economic thought.