DP3076 Screening Risk Averse Agents Under Moral Hazard

Author(s): Bruno Jullien , François Salanié , Bernard Salanié

Publication Date: October 2001

Keyword(s): contracts , insurance

JEL(s): D82

Programme Areas: Industrial Organization

Link to this Page: www.cepr.org/pubs/dps/DP3076.asp

Principal-agent models of moral hazard have been developed under the assumption that the principal knows the agent's risk-aversion. This Paper extends the moral hazard model to the case when the agent's risk-aversion is his private information, so that the model also exhibits adverse selection. We characterize the optimal menu of contracts; while its detailed properties depend on the setting, we show that some of them must hold for all environments. In particular, the power of incentives always decreases with risk-aversion. We also characterize the relationship between the outside option and the optimal contracts. We then apply our results to insurance, managerial incentive pay and corporate governance.