Optimal contracts with a risk-taking agent

Daniel Barron*, George Georgiadis, Jeroen Swinkels

*Corresponding author for this work

Research output: Contribution to journalArticle

Abstract

Consider an agent who can costlessly add mean-preserving noise to his output. To deter such risk-taking, the principal optimally offers a contract that makes the agent's utility concave in output. If the agent is risk-neutral and protected by limited liability, this concavity constraint binds and so linear contracts maximize profit. If the agent is risk averse, the concavity constraint might bind for some outputs but not others. We characterize the unique profit-maximizing contract and show how deterring risk-taking affects the insurance-incentive trade-off. Our logic extends to costly risk-taking and to dynamic settings where the agent can shift output over time.

Original languageEnglish (US)
Pages (from-to)715-761
Number of pages47
JournalTheoretical Economics
Volume15
Issue number2
DOIs
StatePublished - May 1 2020

Keywords

  • contract theory
  • D86
  • gaming
  • M2
  • M5
  • Risk-taking

ASJC Scopus subject areas

  • Economics, Econometrics and Finance(all)

Fingerprint Dive into the research topics of 'Optimal contracts with a risk-taking agent'. Together they form a unique fingerprint.

  • Cite this