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Optimal Incentive Contracts under Moral Hazard When the Agent is Free to Leave

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  • Muehlheusser, Gerd
  • Roider, Andreas
  • Englmaier, Florian
Abstract
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.

Suggested Citation

  • Muehlheusser, Gerd & Roider, Andreas & Englmaier, Florian, 2010. "Optimal Incentive Contracts under Moral Hazard When the Agent is Free to Leave," CEPR Discussion Papers 7914, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:7914
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    More about this item

    Keywords

    Ex-post outside option; Limited commitment; Limited liability; Moral hazard;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • K31 - Law and Economics - - Other Substantive Areas of Law - - - Labor Law
    • M52 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics - - - Compensation and Compensation Methods and Their Effects

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