Optimal Incentive Contracts Under Moral Hazard When the Agent is Free to Leave
52 Pages Posted: 17 Jan 2012
Date Written: August 16, 2011
We characterize optimal incentive contracts in a moral hazard framework extended in two directions. First, after effort provision, the agent is free to leave and pursue some ex-post outside option. Second, the value of this outside option is increasing in effort, and hence endogenous. Optimal contracts may entail properties such as inducing first-best effort and surplus, or non-responsiveness with respect to changes in verifiable parameters. Moreover, while always socially inefficient, separation might occur in equilibrium. Except for the latter, these findings are robust to renegotiation. When the outside option is exogenous instead, the standard results obtain.
Keywords: moral hazard, limited commitment, ex-post outside option, limited liability
JEL Classification: D86, D82, K31, M52
Suggested Citation: Suggested Citation